SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 25, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________.
Commission File No. 0-23226
GRILL CONCEPTS, INC.
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(Exact name of registrant as specified in its charter)
Delaware 13-3319172
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(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
11661 San Vicente Blvd., Suite 404, Los Angeles, California 90049
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Include Area Code: (310) 820-5559
Securities Registered Under Section 12(b) of the Exchange Act:
Title of Each Class Name of Each Exchange on Which Registered
---------------------- -----------------------------------------------
None None
Securities Registered Under Section 12(g) of the Exchange Act:
Common Stock, $.00004 par value
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(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check marked if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports); and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer
an accelerated filer or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act).
Yes [ ] No [X]
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant, based on the closing price on the NASDAQ
Small-Cap Market, as of the close of business June 30, 2005 was approximately
$15,834,000.
Number of shares outstanding of the registrant's common stock, $.00004 par
value, as of March 10, 2006: 5,768,195 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive annual proxy statement to be filed
within 120 days of the Registrant's fiscal year ended December 25, 2005 are
incorporated by reference into Part III.
TABLE OF CONTENTS
PART I Page
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ITEM 1. BUSINESS 3
ITEM 1A. RISK FACTORS 15
ITEM 1B. UNRESOLVED STAFF COMMENTS 19
ITEM 2. PROPERTIES 20
ITEM 3. LEGAL PROCEEDINGS 20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 20
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES 20
ITEM 6. SELECTED FINANCIAL DATA 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 22
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK 38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE 39
ITEM 9A. CONTROLS AND PROCEDURES 39
ITEM 9B. OTHER INFORMATION 39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 40
ITEM 11. EXECUTIVE COMPENSATION 40
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS 40
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 40
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES 40
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES 40
PART I
This Form 10-K contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The Company's actual results could differ materially from
those set forth in the forward-looking statements. Certain factors that might
cause such a difference are discussed in the section entitled "Certain Factors
Affecting Future Operating Results" beginning on page 37 of this Form 10-K.
ITEM 1. BUSINESS
Except as expressly indicated or unless the context otherwise requires, as
used herein, the "Company", "we", "our", or "us", means Grill Concepts, Inc., a
Delaware corporation and its subsidiaries.
GENERAL
Grill Concepts, Inc. and its subsidiaries (the "Company") develops, owns,
operates, manages and licenses upscale casual dining restaurants under the name
"Daily Grill" and fine dining restaurants under the name "The Grill on the
Alley."
The Company was incorporated under the laws of the State of Delaware in
November of 1985. Since our acquisition of Grill Concepts, Inc., a California
corporation ("GCI"), in March of 1995, we have focused principally on the
expansion of the "Daily Grill" and "The Grill on the Alley" restaurant formats
of GCI.
At December 25, 2005, we owned and operated sixteen restaurants and managed
or licensed eight additional restaurants. Twelve Daily Grill restaurants and
four The Grill on the Alley restaurants are owned and operated, six Daily Grill
restaurants are managed and we license two Daily Grill restaurants. With the
exception of three The Grill on the Alley restaurants, and three Daily Grill
restaurants that are operated by partnerships, all of the Daily Grill and The
Grill on the Alley restaurants, which were owned and operated at December 25,
2005, were solely owned and operated by us.
In 2001 we entered into a strategic alliance with Starwood Hotels and
Resorts Worldwide, Inc. to jointly develop restaurant properties in Starwood
hotels. Management believes that the opening of restaurants in hotel properties
in strategic markets will help further establish brand name recognition for the
opening of additional restaurants in those markets.
During 2005, we continued to pursue a strategic growth plan whereby the
Company plans to open, and/or convert, and operate, and/or manage, Daily Grill
and The Grill on the Alley restaurants in hotel properties, and non-hotel based
restaurants, in strategic markets throughout the United States.
During 2005, we opened two restaurants consisting of (1) a 100% owned Daily
Grill, opened in March 2005 in Santa Monica, California and (2) a joint venture
Daily Grill restaurant, opened in May 2005 in downtown Los Angeles, California.
On July 31, 2005 the La Cienega Daily Grill in Los Angeles, California was
closed when the lease expired.
In February 2006, we began construction of a 100% owned Grill on the Alley
at the Galleria shopping center in Dallas, Texas. The restaurant is expected to
open in the summer of 2006.
3
The following table sets forth unaudited restaurant count information for
all restaurants.
2005 2004
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Number of restaurants:
Daily Grill restaurants:
Company Restaurants:
Beginning of year 11 10
Restaurant opening 2 1
Restaurant closings (1) -
----- -----
End of year 12 11
Managed or Licensed Restaurants:
Beginning of year 8 7
Restaurant openings - 1
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End of year 8 8
Total Daily Grill restaurants:
Beginning of year 19 17
Restaurant openings 2 2
Restaurants closed or sold (1) -
----- -----
End of year 20 19
===== =====
Grill restaurants:
Company Restaurants:
Beginning of year 4 4
Restaurant openings - -
----- -----
End of year 4 4
Total Grill restaurants:
Beginning of year 4 4
Restaurant openings - -
----- -----
End of year 4 4
===== =====
Other restaurants:
Managed or Licensed Restaurants:
Beginning of year - 1
Restaurant closings - (1)
----- -----
End of year - -
Total Other restaurants:
Beginning of year - 1
Restaurants closed or sold - (1)
----- -----
End of year - -
===== =====
Total restaurants:
Beginning of year 23 22
Restaurant openings 2 2
Restaurants closed or sold (1) (1)
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End of year 24 23
===== =====
4
The following table sets forth unaudited per restaurant sales information,
comparable restaurant sales information for restaurants open twelve months in
both periods, and total sales information during 2005 and 2004 by restaurant
concept for owned restaurants ("Company Restaurants"):
2005 2004
------------ ------------
Weighted average weekly sales per restaurant:
Daily Grill restaurants:
Company Restaurants $ 59,456 $ 57,757
Grill restaurants:
Company Restaurants $ 85,110 $ 77,545
Change in comparable restaurant sales:
Daily Grill restaurants
Company Restaurants 1.1% 4.6%
Grill restaurants
Company Restaurants 9.8% 2.1%
Total sales:
Daily Grill $37,003,000 $33,809,000
Grill 17,703,000 16,129,000
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Total consolidated sales $54,706,000 $49,938,000
============ ============
We earn management and license fee revenue based on a percentage of gross
sales at restaurants under management and licensing arrangements. Our
management and license fee revenue typically is earned at a rate of five to
eight percent of reported gross sales at these restaurants. In addition to the
base fee we also earn incentive fees based on net income which is reported as
management and license fee revenue. The gross sales of managed and licensed
restaurants are not included in our statements of operations. However, we
consider the disclosure of these gross sales to be a key indicator of brand
strength and important to understanding how changes in gross sales at the
managed and licensed restaurants impact our revenue.
Sales at non-Company owned Grill Concepts-branded restaurants, categorized
as, managed and licensed restaurants were as follows:
2005 2004
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Gross Sales
Managed Daily Grills $19,242,000 $16,382,000
Licensed Daily Grills 7,852,000 8,003,000
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$27,094,000 $24,345,000
============ ============
Management and license fees $ 1,683,000 $ 1,282,000
============ ============
Percent of gross sales 6.2% 5.3%
OPERATING PRINCIPLES
All Grill Concepts' employees are trained to treat each person who visits
our restaurants as a "guest" and not merely a customer. Each server is
responsible for assuring that his or her guest is satisfied. In keeping with
the traditions of the past, each employee is taught that at our restaurants "the
guest is always right." Our policy is to accommodate all reasonable guest
requests, ranging from substitutions of menu items to take-out orders.
In order to assure that our philosophy of guest service is adhered to, all
employees from the kitchen staff to the serving staff undergo extensive training
making each employee knowledgeable not only in our procedures and policies but
in every aspect of operations. Our policy of promoting from within and
providing access to senior management for all employees has produced a work
force which works in a cooperative team approach and has resulted in an employee
turnover rate of just over 65% per year for all employees, considerably below
the industry average which management believes to be approximately 111%.
5
We believe that the familiarity and feeling of comfort, which accompanies
dining in a familiar setting, with familiar food and quality service by familiar
servers, produces satisfied customers who become "regulars." Management believes
that at the restaurants which have been open for over a year repeat business is
significantly greater than the industry average, with many guests becoming
"regulars" in the tradition of the neighborhood restaurant.
Proprietary recipes have been developed for substantially all of the items
offered on our menus. The same recipes are used at each location and all chefs
undergo extensive training in order to assure consistency and quality in the
preparation of food. Virtually all of the menu items offered are cooked from
scratch utilizing fresh food ingredients. Our management believes that our
standards for ingredients and the preparation of menu items are among the most
stringent in the industry.
Each Daily Grill restaurant has up to seven cooks and each Grill has up to
eight cooks on duty during regular lunch and dinner hours to provide prompt,
specialized service. Restaurant staff members utilize a "point-of-sale"
computer system to monitor the movement of food items to assure prompt and
proper service of guests and for fiscal control purposes.
RESTAURANT CONCEPTS
- DAILY GRILL RESTAURANTS
Background. At December 25, 2005, we, through our subsidiaries, owned and
operated, managed or licensed twenty Daily Grill restaurants principally in
Southern California, and the Washington, D.C./Virginia market. Daily Grill
restaurants are patterned after "The Grill on the Alley" in Beverly Hills. See
"-- The Grill on the Alley." After successfully operating The Grill on the
Alley for a number of years, in 1988, the founders of The Grill on the Alley
decided to expand on that theme by opening the first Daily Grill restaurant.
Daily Grill, in an effort to offer the same qualities that made The Grill on the
Alley successful, but at more value oriented prices, adopted six operating
principles that characterize each Daily Grill restaurant: high quality food,
excellent service, good value, consistency, appealing atmosphere and
cleanliness. GCI emphasized those principles in an effort to create a loyal
patron who will be a "regular" at its restaurants.
Restaurant Sites. Current and planned Daily Grill restaurants can be
characterized as either owned, in part or in whole, managed or licensed and as
either hotel based or based in shopping malls and other commercial properties.
Daily Grill locations which are opened, or are scheduled to open in the
following months and years, are owned, managed or licensed as indicated and,
where indicated, are located in the referenced hotels:
Ownership
Opened or Interest,
Scheduled Licensed or
Location Opening Managed
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Brentwood, California September 1988 100%
Newport Beach, California April 1991 100%
Studio City, California August 1993 100%
Palm Desert, California January 1994 100%
Irvine, California September 1996 100%
Los Angeles International Airport January 1997 Licensed
Washington, D.C. March 1997 100%
Tysons Corner, Virginia October 1998 100%
Burbank, California (Hilton Hotel) January 1999 Managed
Washington, D.C. (Georgetown Inn) April 1999 Managed
Universal CityWalk, California May 1999 50%
Skokie, Illinois (DoubleTree Hotel) September 2000 Licensed
San Francisco, California (Handlery Union Square Hotel) February 2002 Managed
Houston, Texas (Westin Galleria) July 2002 Managed
El Segundo (South Bay), California January 2003 50.1%
Portland, Oregon (Portland Westin) September 2003 Managed
Bethesda, Maryland (Hyatt Hotel) January 2004 100%
Long Beach, California (Hilton Hotel) November 2004 Managed
Santa Monica, California March 2005 100%
Downtown Los Angeles, California May 2005 58.4%
6
Each 100% owned Daily Grill restaurant is located in leased facilities.
Site selection is viewed as critical to the success of our restaurants and,
accordingly, significant effort is exerted to assure that each site selected is
appropriate. For non-hotel based restaurants, the site selection process
focuses on local demographics and household income levels, as well as specific
site characteristics such as visibility, accessibility, parking availability and
traffic volume. Each site must have sufficient traffic such that management
believes the site can support at least twelve strong meal periods a week (i.e.,
five lunches and seven dinners). Preferred Daily Grill sites, which
characterize the existing 100% owned restaurants, are high-end, mid-size retail
shopping malls in large residential areas with significant daytime office
populations and some entertainment facilities. Historically, Daily Grill
restaurants have been viewed as desirable tenants drawing traffic to the high
profile malls where we locate and, therefore, have received significant tenant
improvement allowances.
Hotel based Daily Grill restaurants may be newly constructed facilities or
remodeled facilities on the premises of, or adjacent to, a hotel. Such
facilities may be leased, operated pursuant to a partnership, a joint venture, a
license arrangement, or a management agreement. As with non-hotel based
restaurants, site selection is viewed as critical and, accordingly, significant
effort is exerted to assure that each site selected is appropriate. In 1998 we
entered into an agreement with Hotel Restaurant Properties, Inc. ("HRP") under
which they assist us in finding suitable hotel based locations and may negotiate
leases, license or management agreements for those properties. See "-- Hotel
Property Agreement" and " Certain Relationships and Related Transactions".
Existing non-hotel based Daily Grill restaurants range in size from 3,750
to 7,000 square feet of which approximately 30% is devoted to kitchen and
service areas and seat between 100 and 250 persons. Our costs for existing
non-hotel based restaurants, including leasehold improvements, furniture,
fixtures and equipment and pre-opening expenses, have averaged $325 per foot per
restaurant, less tenant improvement allowances.
Existing hotel based Daily Grill restaurants range in size from 5,000 to
8,000 square feet of which approximately 30% is devoted to kitchen and service
areas and seat between 140 and 252 persons. Management anticipates that
additional hotel based Daily Grill restaurants will require minimal capital
investment on our part. However, each hotel restaurant arrangement will be
negotiated separately and our capital investment may vary widely. Our portion of
opening costs of existing hotel restaurants, including leasehold improvements,
furniture, fixtures and equipment and pre-opening expenses, have ranged from
nothing to $513,000 per restaurant.
Menu and Food Preparation. Each Daily Grill restaurant offers a similar
extensive menu featuring over 100 items. The menu was designed to be
reminiscent of the selection available at American-style grill restaurants of
the 1930's and 1940's. During 2005 we redesigned the menu placing a greater
emphasis on steaks, chops and seafood. Daily Grill offers genuine Angus steaks
and chops, as well as, such "signature" items as Cobb salad, Caesar salad,
meatloaf with mashed potatoes, chicken pot pie, hamburgers, fresh fruit cobbler
and key lime pie. The emphasis at the Daily Grill is on freshly prepared
American food served in generous portions.
Entrees range in price, subject to regional differences, from $8.95 for a
hamburger to $29.95 for a char-broiled T-bone steak with all the trimmings.
The average lunch check is $16.00 per person and the average dinner check is
$25.00 per person, including beverage. Daily Grill restaurants also offer a
children's menu with reduced portions of selected items at reduced prices. All
of the existing Daily Grill restaurants offer a full range of beverages,
including beer, wine and full bar service. During the year ended December 25,
2005, food and non-alcoholic beverage sales constituted approximately 83% of the
total restaurant revenues for the Daily Grill restaurants, with alcoholic
beverages accounting for the remaining 17%.
Atmosphere and Service. Most Daily Grill restaurants are open for lunch
and dinner seven days a week and for Sunday brunch. Each Daily Grill location
is designed to provide the sense and feel of comfort. In the tradition of an
old-time American-style grill, the setting is very open with a mix of booths and
tables. Several of the restaurants have counters for singles to feel
comfortable. A number of the Daily Grill restaurants have private dining rooms
for banquets or additional seating. Each restaurant emphasizes the quality and
freshness of Daily Grill food dishes in addition to the cleanliness of
operations. The dining area is well-lit and is characterized by a "high energy
level". Reservations are accepted but not required.
7
- THE GRILL ON THE ALLEY
Background. At December 25, 2005, we, through our subsidiary, GCI, owned
and operated four The Grill on the Alley restaurants ("Grill").
The original Grill is a fine dining Beverly Hills restaurant, which opened
in 1984 and served as the model for the Daily Grill restaurants. The Grill is
set in the traditional style of the old-time grills of New York and San
Francisco, with black-and-white marbled floors and polished wooden booths. The
Grill offers five-star American cuisine and uncompromising service in a
comfortable, dignified atmosphere.
In April of 1996, we acquired the original Grill from a partnership, the
managing partner of which was controlled by our then principal shareholders and
directors.
Restaurant Sites. At December 25, 2005, we operated four Grill
restaurants, two of which were non-hotel based facilities and two of which were
hotel-based facilities.
Grill locations opened, or scheduled to open, in the following months and
years, are owned or managed as indicated and, where indicated, in the referenced
hotels:
Ownership Interest
Location Opened or Managed
------------------------------------- ------------- -----------
Beverly Hills, California January 1984 100.00%
San Jose, California (Fairmont Hotel) May 1998 50.05%
Chicago, Illinois (Westin Hotel) June 2000 60.00%
Hollywood, California November 2001 51.00%
Dallas, Texas Summer 2006 100.00%
Our Grill restaurants are located in leased facilities. As with the Daily
Grill restaurants, site selection is viewed as critical to success and,
accordingly, significant effort is exerted to assure that each site selected is
appropriate. For non-hotel based Grill restaurants, the site selection process
focuses on local demographics and household income levels, as well as specific
site characteristics such as visibility, accessibility, parking availability and
traffic volume. Because of the upscale nature of Grill restaurants, convenience
for business patrons is considered a key site selection criterion.
Hotel based Grill restaurants may be newly constructed facilities or
remodeled facilities on the premises of, or adjacent to, a hotel. Such
facilities may be leased by us, or operated pursuant to a partnership or joint
venture arrangement. As with non-hotel based restaurants, site selection is
viewed as critical to success and, accordingly, significant effort is exerted to
assure that each site selected is appropriate.
Existing non-hotel based Grill restaurants range in size from
approximately 4,300 to 5,600 square feet of which approximately 35% is devoted
to kitchen and service areas and seat 120 to 200 guests.
Existing hotel based Grill restaurants range in size from approximately
8,000 to 8,500 square feet of which approximately 35% to 38% is devoted to
kitchen and service areas and seat 280 to 300 guests.
Because of the unique nature of Grill restaurants, the size, seating
capacity and opening costs of future sites will be unique to each location.
Each hotel restaurant arrangement will be negotiated separately and our capital
investment may vary widely. Total project costs of the existing hotel based
restaurants, including leasehold improvements, furniture, fixtures and equipment
and pre-opening expenses, have ranged from $2.1 million to $3.1 million.
Menu and Food Preparation. Each Grill restaurant offers a similar
extensive menu featuring over 100 items. The menu was designed to be
reminiscent of the selection available at fine American-style grill restaurants
of the 1930's and 1940's, featuring prime steaks, fresh seafood from all over
the world, freshly prepared salads and vegetables served in generous portions.
8
Entrees range in price from $13.25 for a cheeseburger to $39.75 for a prime
porterhouse steak. The average lunch check is $25.00 per person and the average
dinner check is $50.00 per person, including beverage. All of the existing
Grill restaurants offer a full range of beverages, including beer, wine and full
bar service. During the year ended December 25, 2005, food and non-alcoholic
beverage sales constituted approximately 71% of the total restaurant revenues
for Grill restaurants, with alcoholic beverages accounting for the remaining
29%.
Atmosphere and Service. Each Grill restaurant is open at least, for lunch
six days a week and dinner seven days a week. Each Grill location is designed
to provide the sense and feel of comfort and elegance. In the tradition of an
old-time American-style grill, the setting is an open kitchen adjacent to tables
and booths. The open kitchen setting emphasizes the quality and freshness of
food dishes in addition to the cleanliness of operations. The dining area is
well-lit and is characterized by a "high energy level". Reservations are
accepted but are not required.
RESTAURANT MANAGEMENT AND LICENSING ACTIVITIES
In addition to owning and operating Daily Grills and The Grills, we, at
December 25, 2005, provided contract management services for six hotel based
Daily Grill restaurants at the Burbank Hilton, the Georgetown Inn, the Handlery
Hotel, the Westin Galleria, the Portland Westin and the Long Beach Hilton and
had granted licenses to operate two Daily Grill restaurants (at LAX and the
DoubleTree Hotel in Skokie, Illinois).
Under the terms of our management agreements, we are responsible for all
aspects of the restaurant's operation for which we earn a fee, however, we have
no ownership in the restaurant. Restaurant management services include
overseeing the design, development, construction, equipping, furnishing and
operation of the restaurant. Once the restaurant is open to the public, the
manager is responsible for rendering and performing all services in connection
with the operation of the restaurant. Those services include employing,
training and supervising personnel, and purchasing and maintaining adequate
inventory, etc. We are liable for all debts and obligations that we incur on
behalf of the managed outlets including payroll and related costs of the
restaurant staff who are our employees. All such costs are included as
reimbursed costs in our statements of operations and we also record revenue for
those costs that are reimbursed by the restaurants as cost reimbursements.
Each management agreement is individually negotiated and may include an
investment on our part, a management fee and a profit sharing interest. For
restaurants under management at December 25, 2005, we had made investments
ranging from $0 to $500,000, are entitled to management fees, along with HRP,
ranging from 5% to 8.5% of gross revenues and entitled, along with HRP, to 25%
to 35% of annual restaurant profits.
Under restaurant licensing agreements, we earn a licensing fee in exchange
for use of our brand, as well as, the proprietary menu. Under the terms of our
license agreements, licensees are generally responsible for all costs of
construction and operation of the licensed restaurant and we receive license
fees ranging from 2% to 4% of restaurant revenues subject to varying sales
thresholds or minimum license fees negotiated with respect to each licensed
restaurant.
HOTEL PROPERTY AGREEMENT
In order to facilitate our efforts to open restaurants on a large scale
basis in hotel properties, in August of 1998, we entered into the Hotel Property
Agreement with Hotel Restaurant Properties, Inc. ("HRP") pursuant to which HRP
agreed to assist us in locating suitable hotel locations for the opening of our
restaurants. HRP is considered a related party as one of its owners is a family
member of a director and preferred stock holder. In May 1999 the HRP agreement
was amended under the same terms and conditions except that it is now 100% owned
by the family member. HRP is responsible for identifying suitable hotel
locations in which a Grill or Daily Grill can be operated ("Managed Outlets")
and negotiating and entering into leases or management agreements for those
properties. We, in turn, enter into management agreements with HRP or the hotel
owners, as appropriate. We may advance certain pre-opening costs and certain
required advances ("Manager Loans") and will manage and supervise the day-to-day
operations of each Managed Outlet. From the gross management fee, we are
entitled to receive a base overhead fee equal to $1,667 per month per Managed
Outlet. The remaining fee income, less any expenses and after repayments
required on Manager Loans from each Managed Outlet, are allocated 75% to us and
25% to HRP.
9
In July 2001, in conjunction with an investment in the Company by Starwood
Hotels, the Hotel Property Agreement was amended to limit, for so long as we are
subject to the exclusivity provisions of a Property Development Agreement with
Starwood, the amounts payable to HRP to $400,000 annually plus 12.5% of the
amounts otherwise payable to HRP with respect to the Burbank, Georgetown and San
Jose Hilton restaurants.
The operating agreement with HRP contains a clause whereby, HRP has the right to
cause us to purchase HRP (the put option) at any time there is a change in
control or after May 2004 subject to certain conditions and we have the right to
purchase HRP (the call option) after May 2004 subject to certain conditions.
Under the respective put and call options, the purchase price ("APP")
(principally paid in stock) of HRP will be 25% multiplied by 10 (Multiple)
times the operating income of HRP (gross receipts for the prior twelve months
less operating expenses which are averaged over a five year period), with
certain allowed exclusions from operating income minus the principal balance of
any outstanding loans (with certain allowed exclusions) to HRP. Under the put
option the multiple may change if 87.5% multiplied by the closing price of our
common stock divided by EBITDA per share is less than 10. If we sell assets or
stock to certain third parties introduced by HRP which causes a change in
control, then purchase price will be the greater of: (A) $3,000,000 or (B) the
APP, not to exceed $4,500,000.
BUSINESS EXPANSION
Our expansion plans focus on the addition of Daily Grill restaurants with
selected expansion of the Grill restaurant concept also planned.
Management continually reviews possible expansion into new markets and
within existing markets. Such reviews entail careful analysis of potential
locations to assure that the demographic make-up and general setting of new
restaurants is consistent with the patterns which have proven successful at the
existing Daily Grills and Grills. While the general appearance and operations of
future Daily Grills and Grill restaurants are expected to conform generally to
those of existing facilities, we intend to monitor the results of any
modifications to our existing restaurants and to incorporate any successful
modifications into future restaurants. All future restaurants are expected to
feature full bar service.
Our future expansion efforts are expected to concentrate on expansion into
new and existing markets through a combination of Company owned restaurants and
hotel based restaurants pursuant to the Hotel Property Agreement. With the
assistance of HRP, we expect to establish name recognition and market presence
through the opening of Daily Grill and Grill restaurants in fine hotel
properties in strategic markets throughout the United States. Upon establishing
name recognition and a market presence in a market, we intend to construct and
operate clusters of restaurants within those markets. Management intends to
limit the construction and operation of Grill restaurants to one restaurant per
market while constructing multiple Daily Grill restaurants within each market.
The exact number of Daily Grill restaurants to be constructed within any market
will vary depending upon population, demographics and other factors.
Our primary operating markets during 2005 were restaurants in Southern
California, principally the greater-Los Angeles market, and metropolitan
Washington, D.C. During 2005, we opened two non-hotel based Daily Grill
restaurants one in Santa Monica, California in March 2005 and one in downtown
Los Angeles, California in May 2005. We also closed our La Cienega Daily Grill
in July 2005 on expiration of the restaurant lease. At December 25, 2005, we
had entered into a lease covering a Grill restaurant that is expected to open in
the Summer of 2006 in the Galleria shopping center in Dallas, Texas.
Management is presently evaluating the opening of additional non-hotel based
Daily Grill and Grill restaurants in existing markets and in other major
metropolitan areas. Existing markets will be evaluated for expansion in order
to establish market presence and economies of scale. As of March 2006,
conversations are on-going for a number of sites, in addition to the Dallas,
Texas location, but no agreements have been signed. Management anticipates that
the cost to open additional Daily Grill and Grill restaurants will average $325
to $375 per square foot per restaurant, less tenant improvement allowances, with
each restaurant expected to be approximately 6,000 to 7,000 square feet in size.
Actual costs may vary significantly depending upon the tenant improvements,
market conditions, rental rates, labor costs and other economic factors
prevailing in each market in which we pursue expansion.
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We are presently evaluating the opening of additional hotel based Daily
Grill restaurants in existing markets and in other major metropolitan areas.
Each hotel restaurant arrangement will be negotiated separately and the size of
the restaurants, ownership and operating arrangements and capital investment on
our part may vary widely.
STARWOOD DEVELOPMENT AGREEMENT
On July 27, 2001, in conjunction with the purchase by Starwood Hotels and
Resorts of 666,667 shares of our common stock and 666,667 $2.00 warrants for
$1,000,000, we and Starwood entered into a Development Agreement under which we
and Starwood agreed to jointly develop our restaurant properties in Starwood
hotels.
Under the Starwood Development Agreement, either we, or Starwood, may
propose to develop a Daily Grill, Grill or City Bar and Grill restaurant in a
Starwood hotel property. If the parties agree in principal to the development
of a restaurant, the parties will attempt to negotiate either a management
agreement or a license agreement with respect to the operation of the
restaurant.
So long as Starwood continues to meet certain development thresholds set
forth in the Development Agreement, we are prohibited from developing, managing,
operating or licensing our restaurants in any hotel owned, managed or franchised
by a person or entity, other than Starwood, with more than 50 locations operated
under a single brand. Existing hotel based restaurants are excluded from the
exclusive right of Starwood. The development thresholds required to be
satisfied to maintain Starwood's exclusive development rights require,
generally, (1) the signing of an average of one management agreement or license
agreement with respect to Daily Grill restaurants annually over the life of the
Development Agreement, (2) the signing of one management agreement or license
agreement in any two year period with respect to Grill restaurants, and (3) the
signing of an aggregate average of three management agreements or license
agreements with respect to all of our restaurants annually over the life of the
Development Agreement. Satisfaction of the thresholds set forth in the
Development Agreement are determined on each anniversary of the Development
Agreement. With respect to satisfaction of the specific thresholds applying to
Daily Grill restaurants and Grill restaurants, the failure to satisfy the
development thresholds with respect to those individual brands will terminate
the exclusivity provisions relative to such brand but will not affect the
exclusivity rights as to the other brand or in general.
Under the Development Agreement, we are obligated to issue to Starwood
warrants to acquire a number of shares of our common stock equal to four percent
of the outstanding shares upon the attainment of certain development milestones.
Such warrants are issuable upon execution of management agreements and/or
license agreements relating to the development and operation, and the
commencement of operation, of an aggregate of five, ten, fifteen and twenty of
our branded restaurants. If the market price of our common stock on the date
the warrants are to be issued is greater than the market price on the date of
the Development Agreement, the warrants will be exercisable at a price equal to
the greater of (1) 75% of the market price as of the date such warrant becomes
issuable, or (2) the market price on the date of the Development Agreement. If
the market price of our common stock on the date the warrants are to be issued
is less than the market price on the date of the Development Agreement, the
warrants will be exercisable at a price equal to the market price as of the date
such warrants become issuable. The warrants will be exercisable for a period of
five years.
In addition to the warrants described above, if and when the aggregate
number of restaurants operated under the Development Agreement exceeds 35% of
the total Daily Grill, Grill and City Grill-branded restaurants, we will be
obligated to issue to Starwood a warrant to purchase a number of shares of our
common stock equal to 0.75% of the outstanding shares on that date exercisable
for a period of five years at a price equal to the market price at that date.
On each anniversary of that date on which the restaurants operated under the
Development Agreement continues to exceed the 35% threshold, for so long as the
Development Agreement remains effective, we shall issue to Starwood additional
warrants to purchase 0.75% of the outstanding shares on that date at an exercise
price equal to the market price on that date.
Following the events of September 11, 2001, Starwood substantially
curtailed new development activities and only two management agreements have, as
yet, been entered into under the Development Agreement. The exclusivity
agreement has terminated due to the lack of performance on Starwood's part.
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RESTAURANT MANAGEMENT
We strive to maintain quality and consistency in our restaurants through
the careful hiring, training and supervision of personnel and the adherence to
standards relating to food and beverage preparation, maintenance of facilities
and conduct of personnel. We believe that our concept and high sales volume
enable us to attract quality, experienced restaurant management and hourly
personnel. We have experienced a relatively low turnover at every level at our
Daily Grill and Grill restaurants. See "-- Operating Principles" above.
Each Daily Grill and Grill restaurant, including both free standing and
hotel-based restaurants, is managed by one general manager and up to four
managers or assistant managers. Each restaurant also has one head chef and one
or two sous chefs, depending on volume. On average, general managers have
approximately five years experience in the restaurant industry and three years
with us. The general manager has primary responsibility for the operation of the
restaurant and reports directly to an Area Director who in turn reports to our
Vice President of Operations. In addition to ensuring that food is prepared
properly, the head chef is responsible for product quality, food costs and
kitchen labor costs. Each restaurant has approximately 75 employees.
Restaurant operations are standardized, and a comprehensive management manual
exists to ensure operational quality and consistency.
We maintain financial and accounting controls for each Daily Grill and
Grill restaurant through the use of a "point-of-sale" computer system integrated
with centralized accounting and management information systems. Inventory,
expenses, labor costs, and cash are carefully monitored with appropriate control
systems. With the current systems, revenue and cost reports, including food and
labor costs, are produced every night reflecting that day's business. The
restaurant general manager, as well as home office management, receives these
daily reports to ensure that problems can be identified and resolved in a timely
manner. All employees receive appropriate training relating to cost, revenue
and cash control. Financial management and accounting policies and procedures
are developed and maintained by our Corporate Controller, Director of
Information Systems, and Chief Financial Officer.
All managers participate in a comprehensive six-week training program
during which they are prepared for overall management of the dining room. The
program includes topics such as food quality and preparation, guest service,
food and beverage service, safety policies and employee relations. In addition,
we have developed training courses for assistant managers and chefs. We
typically have a number of employees involved in management training, so as to
provide qualified management personnel for new restaurants. Our senior
management meets bi-weekly with each restaurant management team to discuss
business issues, new ideas and revisit the manager's manual. Overall
performance at each location is also monitored with shoppers' reports, guest
comment cards and third party quality control reviews.
Servers at each restaurant participate in approximately ten days of
training during which the employee works under close supervision, experiencing
all aspects of the operations both in the kitchen and in the dining room. The
extensive training is designed to improve quality and guest satisfaction.
Experienced servers are given responsibility for training new employees and are
rewarded with additional hourly pay plus other incentives. Management believes
that such practice fosters a cooperative team approach which contributes to a
lower turnover rate among employees. Representatives of home office management
regularly visit the restaurants to ensure that our philosophy, strategy and
standards of quality are being adhered to in all aspects of restaurant
operations.
PURCHASING
We have developed proprietary recipes for substantially all the items
served at our Daily Grill and Grill restaurants. In order to assure quality and
consistency at each of the Daily Grill and Grill restaurants, ingredients
approved for the recipes are ordered on a unit basis by each restaurant's head
chef from a supplier designated by our Culinary and Purchasing Departments.
Because of the emphasis on cooking from scratch, virtually all food items are
purchased "fresh" rather than frozen or pre-cooked, with one exception being
bread, which is ordered from a central supplier which prepares the bread
according to a proprietary recipe and delivers daily to assure freshness. In
order to reduce food preparation time and labor costs while maintaining
consistency, we work with outside suppliers to produce a limited number of
selected proprietary items such as salad dressings, soups and seasoning
combinations.
We utilize our point-of-sale computer system to monitor inventory levels
and sales, then order food ingredients daily based on such levels. We employ
contract purchasing in order to lock in food prices and reduce short-term
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exposure to price increases. Our Senior Vice President - Culinary establishes
general purchasing policies and is responsible for controlling the price and
quality of all ingredients. The Senior Vice President - Culinary in conjunction
with our team of chefs, constantly monitors the quality, freshness and cost of
all food ingredients. All essential food and beverage products are available, or
upon short notice can be made available, from alternative qualified suppliers.
ADVERTISING AND MARKETING
Our marketing philosophy is to provide our guests with an exceptional and
enjoyable dining experience that creates loyalty and frequent visits. Our
marketing and promotional efforts have been fueled historically by our quality
reputation, word of mouth, and positive local reviews. The Grill on the Alley
and The Daily Grill have been featured in articles and reviews in numerous local
as well as national publications. We supplement our reputation with a program of
marketing and public relations activities designed to keep the Daily Grill and
Grill names before the public. Such activities include media advertising,
direct mail promotions, a birthday club, e-mail marketing, as well as holiday
and special interest events. We also support and participate in local charity
campaigns. These activities are managed by a full time Director of Marketing.
A toll free phone-in guest survey is utilized to gather guest feelings on their
dining experience. During 2005, expenditures for advertising and promotion were
approximately 1.0% of total revenues.
COMPETITION
The Daily Grill restaurants compete within the full-service upscale casual
dining segment. Daily Grill competitors include national and regional chains,
such as Cheesecake Factory and Houston's, as well as local owner-operated
restaurants. Grill restaurants compete within the fine dining segment. Grill
competitors include a limited number of national fine dining chains as well as
selected local owner-operated fine dining establishments. Competition for our
hotel-based restaurants is primarily limited to restaurants within the immediate
proximity of the hotels.
The restaurant business is highly competitive with respect to price,
service, restaurant location and food quality and is affected by changes in
consumer tastes, economic conditions and population and traffic patterns. We
believe we compete favorably with respect to these factors. We believe that our
ability to compete effectively will continue to depend in large measure on our
ability to offer a diverse selection of high quality, fresh food products with
an attractive price/value relationship served in a friendly atmosphere.
EMPLOYEES
We, and our subsidiaries, employ approximately 1,656 people, 31 of whom are
home office personnel and 149 of whom are restaurant managers, assistant
managers and chefs. The remaining employees are restaurant personnel. Of our
employees, approximately 68% are full-time employees, with the remainder being
part-time employees.
Management believes that its employee relations are good at the present
time. An anonymous employee survey is taken each year and the results are
disseminated to keep home office and restaurant management aware of the level of
employee satisfaction.
With the exception of the Chicago Grill on the Alley, none of our employees
are represented by labor unions or are subject to collective bargaining or other
similar agreements. The union contract expired in August 2005 and has been
verbally agreed to for an additional three-year term. Management believes that
its employee relations are good at the present time.
TRADEMARKS AND SERVICE MARKS
We regard our trademarks and service marks as having significant value and
as being important to our marketing efforts. We have registered our "Daily
Grill" mark and "The Grill on the Alley" and "Think Daily" marks and logos. As
well as other marks with the United States Patent and Trademark Office as
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service marks for restaurant service. Our "The Grill on the Alley" mark and
logo is also secured in California. Our policy is to pursue registration of our
marks and to oppose strenuously any infringement.
GOVERNMENT REGULATION
We are subject to various federal, state and local laws affecting our
business. Each of our restaurants is subject to licensing and regulation by a
number of governmental authorities, which may include alcoholic beverage
control, health and safety, and fire agencies in the state or municipality in
which the restaurants are located. Difficulties or failures in obtaining or
renewing the required licenses or approvals could result in temporary or
permanent closure of our restaurants.
Alcoholic beverage control regulations require each of our restaurants to
apply to a state authority and, in certain locations, county and municipal
authorities for a license or permit to sell alcoholic beverages on the premises.
Typically, licenses must be renewed annually and may be revoked or suspended for
cause at any time. Alcoholic beverage control regulations relate to numerous
aspects of the daily operation of our restaurants, including minimum age of
patrons and employees, hours of operation, advertising, wholesale purchasing,
inventory control, and handling, storage and dispensing of alcoholic beverages.
We may be subject in certain states to "dram-shop" statutes, which
generally provide a person injured by an intoxicated person the right to recover
damages from an establishment which served alcoholic beverages to such person.
In addition to potential liability under "dram-shop" statutes, a number of
states recognize a common-law negligence action against persons or
establishments which serve alcoholic beverages where injuries are sustained by a
third party as a result of the conduct of an intoxicated person. We presently
carry liquor liability coverage as part of our existing comprehensive general
liability insurance.
Various federal and state labor laws govern our relationship with our
employees, including such matters as minimum wage requirements, overtime and
other working conditions. Significant additional government-imposed increases
in minimum wages, paid leaves of absence and mandated health benefits, or
increased tax reporting requirements for employees who receive gratuities, could
be detrimental to the economic viability of our restaurants. Management is not
aware of any environmental regulations that have had a material effect on us to
date.
EXECUTIVE OFFICERS
Our executive officers as of December 25, 2005, and their ages and
positions as of that date, are as follows:
Name Age Position
---- ---- -----------
Robert Spivak 62 President and Chief Executive Officer
Michael Weinstock 63 Chairman of the Board and Executive Vice President
John Sola 53 Vice President - Operations and Development
Philip Gay 48 Executive Vice President and Chief Financial Officer
ROBERT SPIVAK has served as our President, Chief Executive Officer and a
director since 1995. Mr. Spivak was a co-founder of our predecessor, Grill
Concepts, Inc. (a California corporation)("GCI") and served as President, Chief
Executive Officer and a director of GCI from the company's inception in 1988
until 1995. Prior to forming GCI, Mr. Spivak co-founded, and operated, The
Grill on the Alley restaurant in Beverly Hills in 1984. Mr. Spivak is a founder
and past president of the Beverly Hills Restaurant Association. Mr. Spivak also
chairs the executive advisory board of the Collins School of Hotel and
Restaurant Management at California State Polytechnic University at Pomona, is
Director Emeritus of the California Restaurant Association and is a member of
the Board of Directors of DiRoNA - Distinguished Restaurants of North America.
MICHAEL WEINSTOCK has served as our Executive Vice President and a director
since 1995 and as Chairman of the Board since 2000. From 1995 to 2000, Mr.
Weinstock served as Vice-Chairman of the Board. Mr. Weinstock was a co-founder
of GCI and served as Chairman of the Board, Vice President and a director of GCI
from 1988 until 1995. Prior to forming GCI, Mr. Weinstock co-founded The Grill
on the Alley restaurant in Beverly Hills in 1984. Mr. Weinstock previously
14
served as President, Chief Executive Officer and a director of Morse Security
Group, Inc., a security systems manufacturer.
JOHN SOLA has served as our Vice President - Operations and Development
since September 2001. Previously, Mr. Sola served as Executive Chef for GCI
from 1988 until 1995 when he assumed the position of Vice President - Executive
Chef of the Company. Mr. Sola oversees all kitchen operations, including
personnel, food preparation and food costs, as well as monitoring and
maintaining the overall performance of the kitchens and establishing procedures
and policies in connection with the opening of new Daily Grill restaurants. Mr.
Sola, along with Mr. Spivak, created the Daily Grill menu. Prior to joining GCI,
Mr. Sola served as opening chef at The Grill on the Alley from inception in 1984
to 1988. Previously, Mr. Sola served in various positions, including Executive
Chef, at a wide range of restaurants.
PHILIP GAY has served as our Executive Vice President and Chief Financial
Officer since July 2004. From March 2000 until he joined Grill Concepts in July
2004, Mr. Gay served as Managing Director of Triple Enterprises, a business
advisory firm that assisted mid-cap sized companies with financing, mergers and
acquisitions, franchising and strategic planning. From March 2000 to November
2001, Mr. Gay served as an independent consultant with El Paso Energy.
Previously he has served as Chief Financial Officer for California Pizza Kitchen
(1987 to 1994), Chief Financial Officer and Interim Chief Executive Officer for
Wolfgang Puck Food Company (1994 to 1996), Chief Executive Officer for Color Me
Mine and has held various Chief Operating Officer and Chief Executive Officer
positions with Diversified Food Group from 1996 to 2000. Mr. Gay is also on the
financial advisory board for Concours Consulting and is on the Board of Motor
Car Parts of America, a publicly traded company that remanufactures starters and
alternators. He is a Certified Public Accountant, a former audit manager at
Laventhol and Horwath and a graduate of the London School of Economics.
There are no family relationships among the executive officers and
directors. Except as otherwise provided in employment agreements, each of the
executive officers serves at the discretion of the Board.
Mr. Spivak has announced his planned retirement effective June 2006 at
which time Mr. Gay is to assume the positions of President and Chief Executive
Officer.
ITEM 1A. RISK FACTORS
The following are certain risk factors that could affect our business,
financial results and results of operations. These risk factors should be
considered in connection with evaluating the forward-looking statements
contained in this Annual Report on Form 10-K because these factors could cause
the actual results and conditions to differ materially from those projected in
forward-looking statements. Before you buy our common stock, you should know
that making such an investment involves some risks, including the risks
described below. The risks that we have highlighted here are not the only ones
that we face. If any of the risks actually occur, our business, financial
condition or results of operations could be negatively affected. In that case,
the trading price of our stock could decline, and you may lose all or part of
your investment.
OUR FUTURE GROWTH AND EXPANSION ARE DEPENDENT UPON OUR ABILITY TO OPEN
ADDITIONAL RESTAURANTS AND OPERATE NEW RESTAURANTS PROFITABLY.
Future growth in sales and profits will depend to a substantial extent on
our ability to increase the number of restaurants we operate, license or manage.
Our ability to open additional restaurants will depend upon a number of factors,
including the availability of suitable locations, our ability to negotiate
leases on acceptable terms, the securing of required governmental permits and
approvals, the hiring and training of skilled restaurant management and hourly
employees, the availability of financing on acceptable terms (if at all),
general economic conditions and other factors, many of which are beyond our
control. Due to the highly customized nature of our restaurant concept and the
complex design, construction, and pre-opening processes for each new location,
the lease negotiation and restaurant development timeframes vary from location
to location and can be subject to unforeseen delays. There can be no assurance
that we will be able to open new restaurants or that, if opened, those
restaurants will be operated profitably.
15
OUR RELATIVE SMALL SIZE MAKES US VULNERABLE TO RISKS ASSOCIATED WITH LACK OF
DIVERSIFICATION AND RISKS ASSOCIATED WITH MANAGING AND SUPPORTING GROWING
OPERATIONS.
We operated 22 restaurants at December 31, 2005. Due to this relatively
small number of restaurants, poor operations at any one restaurant could
materially affect our overall profitability. Even though our revenues have grown
over the last decade, our current restaurant field supervision and corporate
support infrastructures remain relatively small. Accordingly, we remain
vulnerable to a variety of business risks generally associated with smaller,
growing companies. Any failure to continue to upgrade operating, financial, and
restaurant support systems or unexpected difficulties encountered during
expansion could adversely affect our business, financial condition, and results
of operations. Although we believe that our systems and controls are adequate to
address our current needs and we are in the process of upgrading certain of our
operating and financial systems and processes, there can be no assurance that
such upgraded systems and processes will be adequate to sustain future growth,
and that further upgrades will not be necessary.
OUR PROFITABILITY IS SUBJECT TO RISKS ASSOCIATED WITH FLUCTUATIONS IN COSTS OF
KEY INGREDIENTS, LABOR AND UTILITIES.
Our profitability is dependent upon our ability to anticipate and react to
changes in the costs of key operating resources, including food and other raw
materials, labor, utilities and other supplies and services. Various factors
beyond our control, including adverse weather and general marketplace
conditions, may affect the availability and cost of food and other raw
materials. Recent increases in energy costs may have a material adverse impact
on our restaurant profitability if those costs continue at current, or higher,
levels. The impact of inflation on food, labor and occupancy costs can
significantly affect our operations. While management has been able to react to
inflation and other changes in the costs of key operating resources by
increasing prices for menu items, there can be no assurance that we will be able
to continue to do so in the future. There can also be no assurance that we will
continue to generate increases in comparable restaurant sales in amounts
sufficient to offset inflationary or other cost pressures.
OUR SUCCESS IS DEPENDENT UPON OUR ABILITY TO RETAIN THE SERVICES OF KEY SENIOR
MANAGEMENT PERSONNEL AND ATTRACT AND RETAIN ADDITIONAL KEY PERSONNEL.
The success of our business is highly dependent upon the services of our
senior executive team. Robert Spivak, our co-founder and President and Chief
Executive Officer has announced his pending retirement. In conjunction with Mr.
Spivak's pending retirement, Philip Gay, our current Executive Vice President
and Chief Financial Officer is to be promoted to the position of President and
Chief Executive Officer and a new Chief Financial Officer is to be named. Mr.
Spivak has agreed to continue providing services as a part time consultant
following his retirement. Our success will be dependent, during the period
immediately following Mr. Spivak's retirement, upon our ability to successfully
transition our senior management team under the leadership of Mr. Gay and a new
Chief Financial Officer. Further, our success will be dependent upon the
continued services of our senior management team and our ability to attract and
retain skilled management employees at all levels of operations. Poor execution
in our transition of senior management personnel or the loss of services of key
personnel could have a material adverse effect upon our business.
OUR OPERATIONS ARE SUBJECT TO INTENSE COMPETITION AND CHANGES IN CONSUMER
PREFERENCES.
The restaurant industry is highly competitive. There are a substantial
number of restaurant operations that compete directly and indirectly with us,
some of which may have significantly greater financial resources, higher
revenues, and greater economies of scale than we enjoy. The restaurant business
is often affected by changes in consumer tastes and discretionary spending
patterns, national and regional economic conditions, demographic trends,
consumer confidence in the economy, traffic patterns, the cost and availability
of raw materials and labor, purchasing power, governmental regulations and local
competitive factors. Any change in these factors could adversely affect our
restaurant operations. Multi-unit foodservice operations such as ours can also
be substantially affected by adverse publicity resulting from food quality,
illness, injury, health concerns, or operating issues stemming from a single
restaurant. We attempt to manage these factors, but the occurrence of any one of
these factors could cause our business to be adversely affected. We believe that
our restaurants compete favorably in the consumer marketplace with respect to
the attributes of quality, variety, taste, service, consistency, and overall
value.
OUR BUSINESS IS SUBJECT TO SEASONAL FLUCTUATIONS THAT MAY ADVERSELY AFFECT OUR
QUARTERLY OPERATING RESULTS IN SELECT PERIODS.
Our business is subject to seasonal fluctuations. Historically, our highest
earnings have occurred in the first and fourth quarters of the fiscal year, as
our sales in most of our restaurants have typically been higher during the first
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and fourth quarters of the fiscal year. As a result of these factors, results of
operations for any single quarter are not necessarily indicative of the results
that may be achieved for a full fiscal year. Quarterly results have been, and in
the future will continue to be, significantly impacted by the timing of new
restaurant openings and their respective pre-opening costs.
OUR CALIFORNIA BASED RESTAURANTS HAVE IN THE PAST BEEN, AND MAY IN THE FUTURE
BE, SUBJECT TO TEMPORARY CLOSURE DUE TO ENERGY SHORTAGES.
High energy costs and consumption and constrained energy supplies have
periodically resulted in rolling blackouts in California, particularly during
summer months. We have experienced periodic temporary restaurant closures in
the past as a result of such rolling blackouts and may experience similar
closures in the future. Any such closures will result in loss of revenues from
the effected restaurants and potentially higher occupancy and operating costs.
OUR BUSINESS IS SUBJECT TO EXTENSIVE GOVERNMENT REGULATIONS THAT MAY ADVERSELY
AFFECT OUR EXISTING OR PLANNED OPERATIONS OR RESULT IN ADDITIONAL COSTS OR
POTENTIAL LIABILITIES.
Our business is subject to extensive state and local government regulation
in the various jurisdictions in which our restaurants are located, including
regulations relating to alcoholic beverage control, public health and safety and
fire codes. The failure to obtain or retain food and liquor licenses could
adversely affect the operation of our restaurants. Any difficulties, delays or
failures in obtaining and/or retaining licenses, permits or other regulatory
approvals could delay or prevent the opening and/or continued operation of a
restaurant in a particular area. We may also be subject to "dram shop" statutes
in certain states which generally provide a person injured by an intoxicated
person the right to recover damages from an establishment that wrongfully served
alcoholic beverages to the intoxicated person.
We are subject to the Fair Labor Standards Act, which governs such matters
as minimum wages, overtime and other working conditions, along with the
Americans With Disabilities Act, various family leave mandates and a variety of
other laws enacted, or rules and regulations promulgated, by federal, state and
local governmental authorities that govern these and other employment matters.
We expect increases in payroll expenses as a result of federal, state and local
mandated increases in the minimum wage, and although such increases are not
expected to be material, we cannot assure that there will not be material
increases in the future. In addition, our vendors may be affected by higher
minimum wage standards, which may increase the price of goods and services
supplied to us.
WE ARE SUBJECT TO PENDING LITIGATION, AND POTENTIAL LIABILITY, REGARDING
APPLICATION OF EMPLOYMENT REGULATIONS.
Complex issues relating to the interpretation and application of various
labor regulations may result in our incurring unforeseen costs and/or
liabilities relating to compliance with such regulations. Many restaurant
operators in California have been subject to litigation over the last year
relating to non-compliance with California labor provisions mandating that
employees be provided meal and break periods. A former employee has filed a
class action lawsuit against us asserting violation of the applicable California
regulations regarding meal and break periods. While we believe that all of our
employees were provided with the opportunity to take all required meal and rest
breaks, many restaurant operators in California have incurred substantial
expenses in settling similar claims and we may incur substantial expenses in
connection with defending or settling the pending litigation.
A Class Action complaint was filed in the Superior Court of the State of
California for the County of Los Angeles on March 15, 2006. The plaintiff and
those similarly situated (Servers) complain that the company has violated the
labor code by having Servers "Tip Out" Bartenders and Expeditors a percentage of
their tips to these employees who provide no direct table service. The complaint
has labeled this act as "Tip-pooling." The company has not yet been served with
this complaint.
WE MAY BE SUBJECT TO INCREASED LIABILITY RESULTING FROM OUR PARTIAL
SELF-INSURANCE OF WORKERS COMPENSATION CLAIMS.
In order to better manage the cost of our workers compensation expense,
commencing in 2004, we altered our workers compensation coverage to
substantially increase our per event and aggregate deductibles. As a result, we
expect to reduce our recurring cost of workers compensation insurance but are
17
exposed to substantially higher potential losses that could result from claims
under that policy should those claims exceed our prior deductible levels.
WE MAY EXPERIENCE INCREASED COSTS, WORKER RELATED IMPEDIMENTS AND OTHER LOSSES
AT OUR CHICAGO RESTAURANT AS A RESULT OF OUR USE OF UNION WORKERS.
The employees of our Chicago restaurant are members of the Hotel Employees
and Restaurant Employees Union, Local 1, AFL-CIO. As a result of our Chicago
workforce being unionized, we experience higher labor costs in our Chicago
operations, have less managerial control over our workforce and are subject to
certain impediments, delays, costs and other potential risks not faced at our
other restaurants. Accordingly, we may experience unexpected losses or costs in
our Chicago operations.
PROVISIONS IN OUR CHARTER AND IN DELAWARE LAW MAY IMPEDE, DELAY OR PREVENT
POTENTIAL TAKEOVERS THAT MIGHT OTHERWISE BE BENEFICIAL TO OUR STOCKHOLDERS.
Our Certificate of Incorporation and By-Laws contain various provisions and
Delaware law contains certain provisions that could make more difficult a
merger, tender offer or proxy contest involving the Company, even if such events
would be beneficial to the interests of our stockholders. Such provisions could
limit the price that certain investors might be willing to pay in the future for
shares of our Common Stock. In addition, we may issue shares of preferred stock
without stockholder approval on such terms as the Board of Directors may
determine. The rights of the holders of common stock will be subject to, and may
be adversely affected by, the rights of the holders of any preferred stock that
may be issued in the future. Moreover, although the ability to issue preferred
stock may provide flexibility in connection with possible acquisitions and other
corporate purposes, such issuance may make it more difficult for a third party
to acquire, or may discourage a third party from acquiring, a majority of our
voting stock. We have no current plans to issue any shares of preferred stock.
We may in the future adopt other measures that may have the effect of delaying,
deferring or preventing a change in control. Certain of such measures may be
adopted without any further vote or action by the stockholders, although we have
no present plans to adopt any such measures.
IDENTIFICATION OF MATERIAL WEAKNESS IN INTERNAL CONTROL MAY ADVERSELY AFFECT OUR
FINANCIAL RESULTS.
We are subject to the ongoing internal control provisions of Section 404 of
the Sarbanes-Oxley Act of 2002. Those provisions provide for, among other
things, the identification of material weaknesses in internal control that could
indicate a lack of adequate controls to generate accurate financial statements.
Though we routinely assess our internal controls, there can be no assurance that
we will be able to timely remediate material weaknesses, if any, that may be
identified in future periods, or maintain all of the controls necessary for
continued compliance. There likewise can be no assurance that we will be able
to retain sufficient skilled finance and accounting personnel, especially in
light of the increased demand for such personnel among publicly traded
companies. Because we are not an "accelerated filer", as defined in the
Securities Exchange Act of 1934, certain provisions of Section 404 relating to
the provision of a report of management and accompanying auditor's report on a
company's internal controls over financial reporting will not be applicable
until our first fiscal year ending on or after July 15, 2007. Based on the
experiences of other issuers currently subject to the full requirements of
Section 404, we expect that we will incur substantial additional costs in order
to prepare for our first required report under Section 404 and increased
recurring costs thereafter.
OUR STOCK PRICE IS SUBJECT TO VOLATILITY ASSOCIATED WITH MARKET FLUCTUATIONS AS
WELL AS OUR OPERATING PERFORMANCE AND LIMITED TRADING VOLUME IN OUR STOCK.
The price at which the our common stock trades is determined in the
marketplace and may be influenced by many factors, including our performance,
investor expectations, the trading volume in our common stock, general economic
and market conditions and competition.
The market price of our common stock could fluctuate substantially due to a
variety of factors, including our quarterly operating results and those of other
restaurant companies, changes in general conditions in the economy, the
financial markets or the restaurant industry, natural disasters or other
developments affecting our business or our competitors. In addition, in recent
years the stock market has experienced extreme price and volume fluctuations.
This volatility has had a significant effect on the market prices of securities
issued by many companies for reasons unrelated to the operating performance of
these companies.
18
OUR DIRECTORS, EXECUTIVE OFFICERS AND SIGNIFICANT SHAREHOLDERS HOLD A
SUBSTANTIAL PORTION OF OUR STOCK THAT MAY LEAD TO CONFLICTS WITH OTHER
SHAREHOLDERS OVER CORPORATE GOVERNANCE.
Our directors, executive officers and current holders of 5% or more of our
outstanding common stock hold a substantial portion of our stock. At March 10,
2006, Starwood Hotels and Resorts held 666,667 shares of our common stock and
warrants entitling Starwood to purchase an additional 666,667 shares of our
common stock at $2.00 per share. At March 10, 2006, Lewis Wolff, a director,
and his family members and entities controlled by Mr. Wolff and his family
members, held 501,781shares of our common stock, warrants and options to
purchase an additional 246,250 shares of our common stock at prices ranging from
$1.65 to $4.527 per share and 500 shares of Series II Convertible Preferred
Stock that may be converted into 125,000 shares of our common stock, in addition
to options held by Mr. Wolff received in his capacity as a director. Other
members of senior management held in excess of 946,400 shares of our common
stock, as well as options to purchase 217,983 shares of our common stock, at
March 10, 2006. Such persons, acting together, and each acting alone, will be
able to significantly influence all matters requiring shareholder approval,
including the election of directors and significant corporate transactions, such
as mergers or other business combinations.
CONVERSION OF OUR OUTSTANDING CONVERTIBLE SECURITIES COULD SUBSTANTIALLY DILUTE
COMMON STOCK PRICES BECAUSE THE CONVERSION PRICES OF THOSE SECURITIES ARE BELOW
OUR CURRENT MARKET PRICE.
We have issued, and may issue in the future, various securities that are
convertible or exercisable at prices that are lower than the current market
price of our common stock or are subject to adjustment due to a variety of
factors, including fluctuations in the market price of our common stock and the
issuance of securities at an exercise or conversion price less than the
then-current exercise or conversion price of those securities. For example, at
March 10, 2006, we had issued and outstanding 1,309,896 warrants to purchase
shares our common stock at prices ranging from $2.00 to $7.00 per share. On
March 10, 2006, the closing price of our common stock on the Nasdaq SmallCap
Market was $3.35.
The value of our common stock could, therefore, experience substantial
dilution as a result of the conversion or exercise of our outstanding derivative
securities or as a result of any issuance of additional securities at prices
lower than the conversion prices of such securities. Also, as a result of
conversions of our Series II Convertible Preferred Stock and any related sales
of our common stock by the holders, the market price of our common stock could
be depressed.
OUR BUSINESS MAY BE ADVERSELY AFFECTED BY CONFLICTS OF INTEREST ASSOCIATED WITH
DOING BUSINESS WITH AFFILIATES OF CERTAIN DIRECTORS AND PRINCIPAL SHAREHOLDERS.
We are presently party to business arrangements with affiliates of two
directors and principal shareholders. We are party to agreements with two
entities affiliated with Lewis Wolff, a director and principal shareholder. We
lease the site of the San Jose Grill restaurant from an entity in which Mr.
Wolff is a part owner. Similarly, we are party to an agreement with Hotel
Restaurant Properties, Inc., an entity controlled by a member of Mr. Wolff's
family, pursuant to which HRP assists in locating hotel locations for
restaurants and pursuant to which HRP is entitled to a portion of the fees or
profits from those restaurants. During 2005, we paid rents of $257,000 with
respect to the San Jose Grill and paid, or accrued, management fees of $423,000
to HRP. We are also party to various agreements with Starwood Hotels and
Resorts, the employer of one of our directors, Richard Dantas, and one of our
principal shareholders. Under a Development Agreement, we agreed to work with
Starwood to identify potential restaurant locations in Starwood properties and,
subject to negotiating acceptable terms, develop and operate restaurants in
Starwood properties under management or license arrangements. Pursuant to the
Development Agreement, we granted certain exclusivity rights to Starwood and
agreed to grant certain warrants to Starwood based on restaurant openings. As
of December 31, 2005, we operated two restaurants pursuant to management
agreements with Starwood. Our business dealings with Starwood and affiliates of
Mr. Wolff create potential conflicts of interest that could result in our
securing terms that are less favorable than might otherwise be available in the
absence of such conflicts.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable
19
ITEM 2. PROPERTIES
With the exception of certain properties that may be operated pursuant to
management arrangements or partnership or joint venture arrangements, all of our
restaurants are located in space leased from unaffiliated third parties. The
leases have initial terms ranging from 10 to 25 years, with varying renewal
options on all but one of such leases. Most of the leases provide for a base
rent plus payment of real estate taxes, insurance and other expenses, plus
additional percentage rents based on revenues of the restaurant. See
"Business."
The Grill restaurant in San Jose is located in space leased from a hotel
management company that may be deemed to be controlled by one of our directors,
Lewis Wolff.
Our executive offices are located in 5,000 square feet of office space
located in Los Angeles, California. Such space is leased from an unaffiliated
party pursuant to a lease expiring in May 2007.
Management believes that our existing restaurant and executive office space
is adequate to support current operations. We intend to lease, from time to
time, such additional office space and restaurant sites as management deems
necessary to support our future growth plans.
ITEM 3. LEGAL PROCEEDINGS
Restaurants such as those we operate are subject to litigation in the
ordinary course of business, most of the related costs we expect to be covered
by our general liability insurance. However, punitive damages awards are not
covered by general liability insurance. Punitive damages are routinely claimed
in litigation actions against us. There can be no assurance that punitive
damages will not be given with respect to any actions that may arise in the
future.
In June 2004, one of our former hourly restaurant employees filed a class
action lawsuit against us in the Superior Court of California of Orange County.
We requested and were granted a motion to move the suit from Orange County to
Los Angeles County. The lawsuit was then filed in the Superior Court of
California of Los Angeles County in December 2004. The plaintiff has alleged
violations of California labor laws with respect to providing meal and rest
breaks. The lawsuit sought unspecified amounts of penalties and other monetary
payments on behalf of the plaintiffs and other purported class members. We
believe that all of our employees were provided with the opportunity to take all
required meal and rest breaks. The case has been placed in a stay status
pending the outcome of a review by the California Supreme Court on appealed
cases of the same nature. We intend to vigorously defend our position in all
of these matters although the outcome cannot be ascertained at this time. We
have established a reserve of $150,000 for this lawsuit.
A Class Action complaint was filed in the Superior Court of the State of
California for the County of Los Angeles on March 15, 2006. The plaintiff and
those similarly situated (Servers) complain that the company has violated the
labor code by having Servers "Tip Out" Bartenders and Expeditors a percentage of
their tips to these employees who provide no direct table service. The
complaint has labeled this act as "Tip-pooling." The company has not yet been
served with this complaint.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY RELATED STOCKHOLDER
MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is currently traded in the over-the-counter market and is
quoted on the Nasdaq Small-Cap Market ("Nasdaq") under the symbol "GRIL".
20
The following table sets forth the high and low bid price per share for our
common stock for each quarterly period during the last two fiscal years:
High Low
---- ----
2004 - First Quarter 3.65 2.46
Second Quarter 3.44 1.80
Third Quarter 2.96 1.55
Fourth Quarter 2.53 1.45
2005 - First Quarter 3.05 1.81
Second Quarter 4.23 1.85
Third Quarter 4.60 3.01
Fourth Quarter 4.84 3.01
The quotations reflect inter-dealer prices without retail mark-up,
mark-down or commission and may not represent actual transactions.
At March 10, 2006, the closing bid price of our Common Stock was $3.35.
As of March 10, 2006, there were approximately 406 holders of record of our
Common Stock.
We have never declared or paid any cash dividend on our Common Stock and do
not expect to declare or pay any such dividend in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The following tables present selected historical consolidated financial data
derived from our consolidated financial statements. The following data should
be read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our consolidated financial statements
included elsewhere herein.
Fiscal Year Ended December
--------------------------------------------------------
2005 2004 2003 2002 2001
--------- --------- --------- ----------- -----------
(In thousands except per share data)
Statement of Operations Data:
Sales $ 54,706 $ 49,938 $ 45,858 $ 41,826 $ 45,022
Cost reimbursements 14,299 12,439 9,728 7,270 3,594
Management and license fees 1,683 1,282 1,037 901 771
--------- --------- --------- ----------- -----------
Total revenues 70,688 63,659 56,623 49,997 49,387
Operating expenses:
Cost of sales 15,446 14,465 13,274 11,927 12,915
Restaurant operating expenses 32,844 30,552 28,050 25,649 27,100
Reimbursed costs 14,299 12,439 9,772 7,557 3,594
General and administration 4,868 4,472 3,696 3,426 3,381
Depreciation and amortization 2,248 2,005 1,816 1,868 1,838
Pre-opening costs 301 167 182 69 199
Gain on sale of assets (5) (2) (11) (71) (225)
--------- --------- --------- ----------- -----------
Total operating expenses 70,001 64,098 56,779 50,425 48,802
Income (loss) from operations 687 (439) (156) (428) 585
Interest expense, net (128) (272) (331) (331) (564)
--------- --------- --------- ----------- -----------
21
Income (loss) before taxes and minority
interest 559 (711) (487) (792) 21
Provision for income taxes (179) (65) (89) (37) (65)
Minority interest 559 814 704 422 110
--------- --------- --------- ----------- -----------
Net income (loss) 939 38 128 (407) 66
--------- --------- --------- ----------- -----------
Preferred dividends accrued (50) (50) (50) (50) (50)
--------- --------- --------- ----------- -----------
Net income (loss) applicable to
common stock $ 889 $ (12) $ 78 $ (457) $ 16
========= ========= ========= =========== ===========
Net income (loss) per share applicable
to common stock:
Basic $ 0.16 $ 0.00 $ 0.01 $ (0.08) $ 0.00
========= ========= ========= =========== ===========
Diluted $ 0.14 $ 0.00 $ 0.01 $ (0.08) $ 0.00
========= ========= ========= =========== ===========
Weighted average shares outstanding
Basic 5,691,523 5,608,541 5,537,071 5,537,071 4,776,741
========= ========= ========= =========== ===========
Diluted 6,251,042 5,608,541 5,640,842 5,537,071 4,776,741
========= ========= ========= =========== ===========
Fiscal Year Ended December
--------------------------------------------------------
2005 2004 2003 2002 2001
--------- --------- --------- ----------- -----------
(In thousands except per share data)
Balance Sheet Data:
Working capital surplus (deficit) $ (1,277) $ 209 $ 378 $ (1,045) $ (628)
Total assets 21,973 19,749 17,047 16,579 17,321
Long-term debt, less
current portion 877 977 1,254 1,743 2,371
Stockholders' equity 4,806 3,830 3,744 3,616 4,023
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Form 10-K contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The Company's actual results could differ materially from
those set forth in the forward-looking statements. Certain factors that might
cause such a difference are discussed in the sections entitled "Risk Factors"
beginning on page of 15 and "Certain Factors Affecting Future Operating
Results" beginning on page 37 of this Form 10-K.
GENERAL
Grill Concepts develops, owns, operates, manages and licenses full-service
upscale casual dining restaurants under the name "Daily Grill" and fine dining
restaurants under the name "The Grill on the Alley."
Our revenues are derived from sales at company-owned restaurants,
management and license fees from restaurants managed or licensed by us and
reimbursements of operating expenses of managed outlets.
During the fiscal year ended December 25, 2005, we owned and operated, for
the full fiscal year, fourteen restaurants (ten Daily Grill and four Grill
restaurants), including two Daily Grill and three Grill restaurants owned in
partnership with third parties. During fiscal 2005, we also operated one fully
owned Daily Grill that opened in March, one Daily Grill owned in partnership
that opened in May and one fully owned Daily Grill which closed in July.
Also during fiscal 2005, we managed or licensed, for the full fiscal year,
six Daily Grill restaurants.
22
During the fiscal year ended December 26, 2004, we owned and operated, for
the full fiscal year, fourteen restaurants (ten Daily Grill and four Grill
restaurants), including two Daily Grill and three Grill restaurants owned in
partnership. During 2004, we also operated one owned Daily Grill that opened in
January.
Also during fiscal 2004, we managed or licensed, for the full fiscal year,
six Daily Grill restaurants. During fiscal 2004, we commenced management of one
Daily Grill that opened in November and terminated our license relating to the
San Jose City Bar and Grill.
Sales revenues are derived from sales of food, beer, wine, liquor and
non-alcoholic beverages. Approximately 79% of combined 2005 sales were food and
21% were beverage. Sales revenues from restaurant operations are primarily
influenced by the number of restaurants in operation at any time, the timing of
the opening of such restaurants and the sales volumes of each restaurant.
Management and license fee revenues are derived from individually
negotiated arrangements by which we manage restaurants on behalf of third
parties or license to third parties the right to operate Daily Grill
restaurants. Management and license fees are primarily influenced by the number
of management and license arrangements in place, the negotiated management or
license fee and the revenues of the managed or licensed restaurants. Management
and license fees typically range from five to eight percent of gross sales of
the subject restaurants. Management and license fee revenues also include
incentive fees we receive which are based on a percentage of net income.
Revenues derived from reimbursement of operating expenses of managed
outlets relate to contractual undertakings relating to managed restaurants
wherein we assume responsibility for some or all operating expenses of managed
restaurants and the restaurant owner undertakes to reimburse all of those
expenses. Pursuant to the guidance of EITF 01-14 and EITF 99-19, we are
considered to be the primary obligor with respect to the reimbursed expenses
and, as such, report the reimbursed expenses as revenues with the expenses being
reported as "Reimbursed Costs" under operating expenses.
Expenses are comprised primarily of cost of food and beverages, restaurant
operating expenses, including payroll, rent and occupancy costs and reimbursed
costs. Our largest expenses are payroll and the cost of food and beverages,
which is primarily a function of the price of the various ingredients utilized
in preparing the menu items offered at our restaurants. Restaurant operating
expenses consist primarily of wages paid to part-time and full-time employees,
rent, utilities, insurance and taxes. Reimbursed costs are costs incurred on
behalf of managed restaurants that are reimbursable by the managed restaurant.
We typically analyze these costs as a percentage of restaurant sales, not total
revenues.
In addition to restaurant operating expenses, we pay certain general and
administrative expenses that relate primarily to operation of our home office.
Home office general and administrative expenses consist primarily of salaries of
officers, management personnel and clerical personnel, rent, legal and
accounting costs, travel, insurance and office expenses.
RESULTS OF OPERATIONS
The following table sets forth certain items as a percentage of total
revenues from our Statements of Operations during 2005, 2004 and 2003. As noted
above, we typically analyze our operating expenses as a percentage of sales
revenues, not total revenues.
Fiscal Year Ended December
--------------------------
2005 2004 2003
------ ------ ------
Sales revenues 77.4% 78.5% 81.0%
Cost reimbursements 20.2 19.5 17.2
Management and licensing fees 2.4 2.0 1.8
------ ------ ------
Total revenues 100.0 100.0 100.0
23
Cost of sales 21.8 22.7 23.4
Restaurant operating expense 46.4 48.0 49.5
Reimbursed costs 20.2 19.5 17.3
General and administrative expense 6.9 7.0 6.5
Depreciation and amortization 3.2 3.2 3.2
Pre-opening costs 0.4 0.3 0.3
------ ------ ------
Total operating expenses 99.0 100.7 100.3
------ ------ ------
Operating income (loss) 1.0 (0.7) (0.3)
Interest expense, net (0.2) (0.4) (0.6)
------ ------ ------
Income (loss) before income tax and
minority interest 0.8 (1.1) (0.9)
Provision for taxes (0.3) (0.1) (0.2)
Minority interest 0.8 1.3 1.3
------ ------ ------
Net income 1.3% 0.1% 0.2%
====== ====== ======
FISCAL YEAR 2005 COMPARED TO FISCAL YEAR 2004
Revenues. Revenues for 2005 increased 11.0% to $70.7 million from $63.7
million in 2004. Sales revenues increased 9.6% to $54.7 million in 2005 from
$49.9 million in 2004. Reimbursed managed outlet operating expenses increased
15.0% to $14.3 million from $12.4 million in 2004. Management and license fee
revenues increased to $1.7 million in 2005 from $1.3 million in 2004. The
restaurant sales information excludes revenue related to reimbursed operating
expenses and management and license fees.
Sales for Daily Grill restaurants increased by 9.5% from $33.8 million in
2004 to $37.0 million in 2005. The increase in sales revenues for the Daily
Grill restaurants from 2004 to 2005 was primarily attributable to opening of the
Downtown Daily Grill ($2.1 million) and the Santa Monica Daily Grill ($1.9
million), a slight increase at the Bethesda Daily Grill which opened in January
2004 ($0.1 million) and an increase in same store sales of 1.1% ($0.3 million)
for restaurants open for 12 months in both 2005 and 2004 offset by a decrease in
sales at the LaCienega Daily Grill which closed in July 2005 ($1.2 million).
Weighted average weekly sales at the Daily Grill restaurants increased 2.9% from
$57,757 in 2004 to $59,456 in 2005.
Sales for Grill restaurants increased by 9.8% from $16.1 million in 2004 to
$17.7 million in 2005. The increase in sales revenues for the Grill restaurants
from 2004 to 2005 was primarily attributable to increased guest counts supported
by improved check averages. Weighted average weekly sales at the Grill
restaurants increased 9.8% from $77,545 in 2004 to $85,110 in 2005.
Price increases were implemented during the fourth quarter of 2005 for a
large percentage of the menu items. Selected price increases may be implemented
from time to time in the future, consistent with the casual dining industry and
how the economy fares. Future revenue growth is expected to be driven
principally by a combination of expansion into new markets and the opening of
additional restaurants and establishment of market share in those new markets as
well as increases in guest count at existing restaurants and selected price
increases. When entering new markets where we have not yet established a market
presence, sales levels are expected to be lower than in existing markets where
we have a concentration of restaurants and high customer awareness. Although
our experience in developing markets indicates that the opening of multiple
restaurants within a particular market results in increased market share,
decreases in comparable restaurant sales could result.
Cost reimbursements increased in 2005 primarily due to the full year
operation of the Long Beach Daily Grill and improved sales at other managed
restaurants.
Management and license fee revenues during 2005 were attributable to (1)
restaurant management services relating to six hotel based restaurants which
accounted for $1,462,000 of management fees, and (2) licensing fees from the two
licensed Daily Grill restaurants which totaled $221,000. The increase in
management and license fees during 2005 was attributable to (1) management of
one Daily Grill open a full year compared to 6 weeks in 2004, (2) 10% or more
24
increases in sales at three managed Daily Grills and (3) a 10% sales increase at
one licensed Daily Grill, partially offset by the termination in 2004 of our
licensed San Jose City Bar and Grill operation.
Operating Expenses and Operating Results. Total operating expenses,
including cost of sales, restaurant operating expenses, reimbursed costs,
general and administrative expense, depreciation and amortization, and
pre-opening costs, increased 9.2% to $70.0 million in 2005 from $64.1 million in
2004.
Cost of Sales. Cost of sales consists exclusively of the cost of food and
beverages sold. Cost of sales increased by 6.8% ($1.0 million) and decreased
almost a full percentage point to 28.2% as a percentage of sales in 2005
compared to 29.0% in 2004. The increase in cost of sales was attributable to the
opening of new restaurants and increased sales generally. The decrease in cost
of sales as a percentage of sales reflects a combination of improved cost
controls, purchasing efficiencies and price increases.
Restaurant Operating Expenses. Restaurant operating expenses consist of
wages and benefits of restaurant personnel and all other operating expenses. The
operating expenses include, but are not limited to, supplies, advertising,
occupancy, maintenance and utilities. Restaurant operating expenses increased
7.5% to $32.8 million in 2005 from $30.6 million in 2004. As a percentage of
sales, restaurant operating expenses represented 60.0% in 2005 and 61.2% in
2004. The increase in restaurant operating expenses was primarily attributable
to the opening during 2005 of two Daily Grills accounting for $2.5 million of
the increased costs partially offset by the closing of one restaurant resulting
in a decrease of $0.8 million. For comparable restaurants the expenses as a
percentage of sales improved slightly to 60.0% from 60.2% in 2004.
Reimbursed Costs. Reimbursed costs increased 15.0% from $12.4 million in
2004 to $14.3 million in 2005. These expenses represent the operating costs for
which we are the primary obligor of the restaurants we do not consolidate. The
increase is primarily due to the full year operations of one Daily Grill that
was open for only six weeks in 2004 and improved sales at other restaurants.
General and Administrative. General and administrative expenses rose to
$4.9 million in 2005 compared to $4.5 million in 2004. General and
administrative expenses represented 6.9% of total revenues in 2005 as compared
to 7.0% of total revenues in 2004. The dollar increase was primarily the result
of corporate level bonuses ($375,000), a reserve for settlement of the meals and
breaks lawsuit ($150,000) and increased professional services ($27,000), offset
by decreased office expenses ($87,000), travel expenses ($36,000) and bad debt
due to continued under performance at the Portland Daily Grill ($23,000).
Depreciation and Amortization. Depreciation and amortization expense was
$2.2 million during 2005 and $2.0 million in 2004. The increase was due
primarily to the addition of two Daily Grills during 2005.
Pre-opening costs. Pre-opening costs totaled $301,000 in 2005 as compared
with $167,000 in 2004. These pre-opening costs were attributable to the opening
of two Daily Grills in 2005 and the opening of one Daily Grill in 2004.
Interest Expense. Interest expense, net, totaled $128,000 during 2005 as
compared to $272,000 in 2004. The decrease in interest expense was primarily
attributable to substantially reduced warrant amortization in 2005 and lower
interest on maturing debt combined with interest earned on funds in restricted
accounts.
Provision for income taxes. The 2005 provision for income tax is comprised
of amounts for federal and state taxes reduced by the income tax benefit
resulting from the recognition of deferred tax asset that is considered more
likely than not to be realized of $0.6 million. The provision for income taxes
differs from the amount of income tax expense that would result from applying
the domestic federal statutory tax rates to pretax income primarily due to the
change in the deferred income tax valuation allowance, minority interests' share
of net loss of subsidiaries and the impact of state income taxes.
Minority Interest. We reported a minority interest in the loss of our
majority owned subsidiaries of $559,000 during 2005, consisting of a minority
interest in the earnings of San Jose Grill on the Alley, LLC of $162,000, a
minority interest in the loss of The Grill on Hollywood, LLC of $109,000, a
minority interest in the loss of The Daily Grill at Continental Park, LLC of
$194,000, a minority interest in the loss of the 612 Flower Daily Grill LLC of
$138,000 and a partnership loss in the Universal CityWalk Daily Grill of
$280,000. During 2004 we reported a minority interest in the loss of our
25
majority owned subsidiaries of $814,000, consisting of a minority interest in
the earnings of San Jose Grill on the Alley, LLC of $154,000, a minority
interest in the loss of The Grill on Hollywood, LLC of $357,000, a minority
interest allocation from The Daily Grill at Continental Park of $483,000, a
minority interest in the loss of the 612 Flower Daily Grill LLC of $3,000and
partnership loss in the Universal CityWalk Daily Grill of $125,000. The Company
allocates profits and losses to the minority interest in its partially owned
subsidiaries based on the underlying economics of the investment. These may or
may not reflect the Company's ownership percentage and can be inconsistent with
the allocation provisions specified in the joint venture agreements. Where there
is a disparity among the ownership percentages, the terms of the agreements and
the underlying economics, the Company utilizes a hypothetical liquidation model
to allocate profits and losses. Under this model, all of the venture's assets
and liabilities as reflected in the balance sheet are assumed to be realized at
their GAAP carrying values. The hypothetical liquidating proceeds are calculated
at the end of each period and applied to the capital accounts as would occur
under a true liquidation scenario. The change in this balance from period to
period represents the investors' share of the income or loss.
Net Income. We reported a net income of $939,000 in 2005 as compared to
a net income of $38,000 in 2004.
FISCAL YEAR 2004 COMPARED TO FISCAL YEAR 2003
Revenues. Revenues for 2004 increased 12.4% to $63.7 million from $56.6
million in 2003. Sales revenues increased 8.9% to $49.9 million in 2004 from
$45.9 million in 2003. Reimbursed managed outlet operating expenses increased
27.9% to $12.4 million from $9.7 million in 2003. Management and license fee
revenues increased to $1.3 million in 2004 from $1.0 million in 2003. The
restaurant sales information excludes revenue related to reimbursed operating
expenses and management and license fees.
Sales for Daily Grill restaurants increased by 12.5% from $30.1 million in
2003 to $33.8 million in 2004. The increase in sales revenues for the Daily
Grill restaurants from 2003 to 2004 was primarily attributable to an increase in
same store sales of 4.6% ($1.3 million) for restaurants open for 12 months in
both 2004 and 2003 and opening of the Bethesda Daily Grill ($2.9 million).
Weighted average weekly sales at the Daily Grill restaurants decreased 1.1% from
$58,052 in 2003 to $57,757 in 2004.
Sales for Grill restaurants increased by 2.1% from $15.8 million in 2003 to
$16.1 million in 2004. The increase in sales revenues for the Grill restaurants
from 2003 to 2004 was attributable to the improved check averages partially
offset by decreased guest counts. Weighted average weekly sales at the Grill
restaurants increased 2.1% from $75,971 in 2003 to $77,545 in 2004.
Price increases were last implemented during the first quarter of 2003 for
certain menu items.
Cost reimbursements increased in 2004 primarily due to the full year
operation of Portland Daily Grill, the opening of Long Beach Daily Grill and
improved sales at other managed restaurants.
Management and license fee revenues during 2004 were attributable to (1)
hotel restaurant management services which accounted for $1,073,000 of
management fees, and (2) licensing fees from the LAX Daily Grill, Skokie,
Illinois Daily Grill and the San Jose City Bar and Grill which totaled $209,000.
The increase in management fees during 2004 was attributable to (1) management
of the Portland Daily Grill open a full year compared to 15 weeks in 2003, (2) a
26.6% increase in sales at the San Francisco Daily Grill and (3) sales increase
of over 6% at the Georgetown Daily Grill, Burbank Daily Grill and Houston Daily
Grill. We terminated the licensed operation of the San Jose City Bar and Grill
in 2004.
Operating Expenses and Operating Results. Total operating expenses,
including cost of sales, restaurant operating expenses, reimbursed costs,
general and administrative expense, depreciation and amortization, and
pre-opening costs, increased 12.9% to $64.1 million in 2004 from $56.8 million
in 2003.
Cost of Sales. Cost of sales consists exclusively of the cost of food and
beverages sold. Cost of sales increased by 9.0% ($1.2 million) and increased
slightly as a percentage of sales to 29.0% in 2004 compared to 28.9% in 2003.
The increase in cost of sales reflects the opening of new restaurants and higher
revenues, generally. The slight increase in cost of sales as a percentage of
sales reflects fluctuation in food costs.
26
Restaurant Operating Expenses. Restaurant operating expenses consist of
wages and benefits of restaurant personnel and all other operating expenses. The
operating expenses include, but are not limited to, supplies, advertising,
occupancy, maintenance and utilities. Restaurant operating expenses increased
8.9% to $30.6 million in 2004 from $28.1 million in 2003. As a percentage of
sales, restaurant operating expenses represented 61.2% in both 2004 and 2003.
The opening during 2004 of the Bethesda Daily Grill accounted for $1.9 million
of the increase. For comparable restaurants the expenses as a percentage of
sales improved slightly to 60.3% from 60.5% in 2003.
Reimbursed Costs. Reimbursed costs increased 27.3% from $9.8 million in
2003 to $12.4 million in 2004. These expenses represent the operating costs for
which we are the primary obligor of the restaurants we do not consolidate. The
increase is primarily due to the full year operations of the Portland Daily
Grill, the opening of the Long Beach Daily Grill and improved sales at other
restaurants.
General and Administrative. General and administrative expenses rose to
$4.5 million in 2004 compared to $3.7 million in 2003. General and
administrative expenses represented 7.0% of total revenues in 2004 as compared
to 6.5% of total revenues in 2003. The increase was the result of higher payroll
and related benefits related to building staff for our growth ($367,000),
increased professional services ($248,000), increased travel due to new
locations ($76,000), and reserve for uncollected management fees ($109,000).
Depreciation and Amortization. Depreciation and amortization expense was
$2.0 million during 2004 and $1.8 million in 2003. The increase was due
primarily to the addition of the Bethesda Daily Grill.
Pre-opening costs. Pre-opening costs totaled $167,000 in 2004 as compared
with $182,000 in 2003. These pre-opening costs were attributable to the opening
in January 2003 of the South Bay Daily Grill and the opening of the Bethesda
Daily Grill in January 2004.
Interest Expense. Interest expense, net, totaled $272,000 during 2004 as
compared to $331,000 in 2003. The decrease in interest expense was primarily
attributable to reduced debt levels as a result of the maturing of loans.
Provision for income taxes. The income tax provision for 2004 and 2003
are due mainly to state taxes as the company has a federal net operating loss to
carry forward. The tax rates in 2004 and 2003 were comprised of the federal and
state statutory rates, less any permanent items and tax credits based on the
annual estimated effective tax rates for the respective years.
Minority Interest. We reported a minority interest in the loss of our
majority owned subsidiaries of $814,000 during 2004, consisting of a minority
interest in the earnings of San Jose Grill on the Alley, LLC of $154,000, a
minority interest in the loss of The Grill on Hollywood, LLC of $357,000, a
minority interest in the loss of The Daily Grill at Continental Park, LLC of
$483,000, a minority interest in the loss of the 612 Flower Daily Grill LLC of
$3,000 and a partnership loss in the Universal CityWalk Daily Grill of $125,000.
During 2003 we reported a minority interest in the loss of our majority owned
subsidiaries of $704,000, consisting of a minority interest in the earnings of
San Jose Grill on the Alley, LLC of $141,000, a minority interest in the loss of
The Grill on Hollywood, LLC of $366,000 and a minority interest allocation from
The Daily Grill at Continental Park of $334,000 and partnership loss in the
Universal CityWalk Daily Grill of $145,000. The Company allocates profits and
losses to the minority interest in its partially owned subsidiaries based on the
underlying economics of the investment. These may or may not reflect the
Company's ownership percentage and can be inconsistent with the allocation
provisions specified in the joint venture agreements. Where there is a disparity
among the ownership percentages, the terms of the agreements and the underlying
economics, the Company utilizes a hypothetical liquidation model to allocate
profits and losses. Under this model, all of the venture's assets and
liabilities as reflected in the balance sheet are assumed to be realized at
their GAAP carrying values. The hypothetical liquidating proceeds are calculated
at the end of each period and applied to the capital accounts as would occur
under a true liquidation scenario. The change in this balance from period to
period represents the investors' share of the income or loss.
Net Income. We reported a net income of $38,000 in 2004 as compared to a
net income of $128,000 in 2003.
27
LIQUIDITY AND CAPITAL RESOURCES
CASH POSITION AND SHORT-TERM LIQUIDITY. At December 25, 2005, we had a
working capital deficit of $1.3 million and a cash balance of $3.2 million as
compared to a working capital surplus of $0.2 million and a cash balance of $1.4
million at December 26, 2004.
The increase in our cash position reflects the following cash flows:
2005 2004 2003
------------ ------------ -----------
Net cash provided by operating activities $ 4,567,000 $ 4,133,000 $1,845,000
------------ ------------ -----------
Net cash used in investing activities (3,962,000) (3,671,000) (767,000)
------------ ------------ -----------
Net cash provided (used in) financing activities 1,149,000 (551,000) (872,000)
------------ ------------ -----------
Net increase (decrease) in cash and cash
equivalents $ 1,754,000 $ (89,000) $ 206,000
------------ ------------ -----------
Included in cash flows from operating activities were tenant improvement
allowances of $1.9 million in 2005, $2.1 million in 2004 and $1.8 million in
2003.
The adverse change in working capital position was principally attributable
to an increase in accrued expenses of $1.9 million which, in turn, was
attributable to the two new restaurants, executive and restaurant bonuses, and
increased reserve for worker's compensation claims. The increase in accrued
expenses favorably effected our cash provided from operations in 2005.
Our need for capital resources historically has resulted from, and for the
foreseeable future is expected to relate primarily to, the construction and
opening of new restaurants. Funds necessary to operate restaurants under
management agreements are usually funded by cash generated by the restaurants.
Sales from these outlets are deposited into an agency account belonging to the
owner and we pay the outlet operating expenses, including our fee, from this
agency account. Historically, we have funded our day-to-day operations through
operating cash flows that have ranged from a $1.8 to $4.6 million over the past
three fiscal years. Growth has been funded through a combination of bank
borrowing, loans from stockholders/officers, the sale of debentures and stock,
loans and tenant allowances from certain of our landlords, and, beginning in
1999, through joint venture arrangements.
FINANCING FACILITIES. At December 25, 2005, the Company had $143,000 owing
under equipment leasing financing transactions, an obligation to a member of
Chicago - The Grill on the Alley, LLC of $0.8 million for a guaranteed return of
its invested capital, loans from stockholders/officers/directors of $0.2
million, and loans/advances from a landlord of $0.1 million.
On August 1, 2000, we received a $400,000 loan from private individuals.
The loan bears interest at 9% and is payable in monthly installments over four
years. In connection with the loan, we issued 40,000 warrants. In June 2001
the lender became a member of our Board of Directors and the loan was
reclassified as related party debt. The loan had been paid in full at December
26, 2004.
We have a bank credit facility which will expire August 4, 2006. The terms
of the bank credit facility provide for financing in the form of a revolving
line of credit in the amount of $500,000, an irrevocable standby letter of
credit in the amount of $860,000, increased to $1,010,000 in January 2006, and
equipment financing in the amount of $500,000. In November 2005 we amended the
equipment financing portion of the facility increasing the amount to $600,000
for equipment to be delivered on or before June 30, 2006, with payments to be
for terms of three to five years with interest at the banks reference rate. The
facility is secured by assets and is subject to certain standard borrowing
covenants. We have not utilized any funds from the current or prior lines of
credit dating back to 2001 and only utilized $158,000 of equipment leasing.
Interest is at the bank's variable reference rate.
In March 2006 we signed a new financing agreement at which time the
previous line was terminated. The Credit Agreement provides for a revolving term
loan (the "Loan") to the Company of the lesser of (1) $8.0 million, or (2) 2.25
times the Company's trailing 12 month EBITDA. Funds may be borrowed under the
Credit Agreement, subject to satisfaction of all conditions of funding, in
minimum monthly advances of $500,000. Proceeds of the Loan may be used to pay
expenses of the Loan and for general corporate purposes. The interest rate on
the Loan is, at the option of the Company and subject to certain limitations on
the use of LIBOR based loans, equivalent to either (1) prime rate, but not less
than 7%, plus an applicable margin, or (2) the London Interbank Offered Rate,
but not les than 4%, plus an applicable margin. The margin, in each case, varies
based upon the Company's leverage ratio (funded debt to EBITDA, each as defined)
and ranges from 2.75% to 3.50% with respect to prime rate loans and 5.50% to
28
6.25% with respect to LIBOR loans. The current interest rate is equal to 10.5%
and will be adjusted quarterly commencing in the fourth quarter of 2006.
The Credit Agreement provides that the Company will pay all expenses
incurred in connection with the Loan, including expenses incurred by the Lender.
By separate agreement, the Company agreed to pay certain fees associated with
the Loan, including a loan fee of $120,000, an unused line fee of 0.5% of the
unused portion of the credit facility payable monthly, a loan servicing fee of
$3,000 per month.
The Loan matures, and is payable in full, on March 9, 2011 subject to
mandatory prepayment to the extent, if any, that the outstanding principal
balance of the Loan exceeds 2.25 times trailing 12 month EBITDA or upon the
occurrence of certain defined extraordinary events. The Company may prepay
amounts owing under the Credit Agreement subject to payment of a prepayment
premium of (1) 3% with respect to prepayments occurring on or before March 9,
2007, and (2) 1% with respect to prepayments occurring after March 9, 2007 and
on or before March 9, 2008.
The Company's obligations under the Credit Agreement are secured by a first
lien on all of the Company's assets, including all of the capital stock and
other equity interests held by the Company in its subsidiaries, subject to
existing liens on such assets. The Loan requires the Company to comply with
certain ordinary lending covenants. These include, among others, financial
covenants relating to maximum debt to EBITDA ratio, minimum EBITDA and maximum
capital expenditures. The Company must also comply with certain information
requirements, including providing periodic financial statements and projections
as well as notices of defaults, litigation and other matters, maintenance of
insurance and compliance with laws as well as limitations on liens and
encumbrances, indebtedness, dispositions, dividends and retirement of capital
stock, consolidations and mergers, changes in nature of business and other
operating, financial and structural limitations.
Events of default in the Credit Agreement include, among others, (a) the
failure to pay when due the obligations owing under the Credit Agreement, (b)
the failure to perform and not timely remedy certain covenants, (c) certain
cross defaults or cross accelerations, (d) the occurrence of bankruptcy or
insolvency events, (e) the failure to make certain payments, or the occurrence
of certain events, relating to retirement plans, (f) certain adverse judgments
against the Company or any of its subsidiaries, (g) certain changes in ownership
of the Company's stock or the board of directors, or (h) the occurrence of, and
failure to remedy, a Material Adverse Effect (as defined in the Credit
Agreement). Upon the occurrence of an event of default, the Lender may terminate
the loan commitment and declare the Loan due and payable in full.
On March 31, 2006, the Company borrowed $1 million under the terms of the
Credit Agreement with Diamond Creek Investment Partners LLC. The borrowed funds
were primarily used to retire $930,132 of collateralized subordinated notes and
manditorily redeemable capital obligations owed to The Michigan Avenue Group
("MAG") by the Company's subsidiary Chicago - The Grill on the Alley LLC
("Chicago Grill LLC"), and guaranteed by the Company, with the balance used for
general working capital. The retired obligations related to the initial funding
provided by MAG, as a member/investor in Chicago Grill LLC, with respect to the
Company's The Grill on the Ally restaurant in Chicago.
OPERATING LEASES. During 2005, we, and our subsidiaries, were obligated
under eighteen leases covering the premises in which our Daily Grill and Grill
Restaurants are located as well as leases on our executive offices. Such
restaurant leases and the executive office lease contain minimum rent provisions
which provided for the payment of minimum aggregate annual rental payments of
approximately $3.3 million in 2005 and percentage rent obligations, above and
beyond minimum rent, of $0.6 million. Our minimum rent obligations for 2006 are
$3.6 million.
CONTRACTUAL OBLIGATIONS. Our only material contractual obligations
requiring determinable future payments on our part are various notes payable and
our leases relating to our executive offices and restaurants, each of which is
described above.
The following table details our contractual obligations as of December 25,
2005:
Payments due by period
-----------------------------------------------------------------
Total 2006 2007 - 2008 2009 - 2010 Thereafter
Long-term debt (1) $ 1,237,000 $ 361,000 $ 463,000 $ 361,000 $ 52,000
Capital lease obligations - - - - -
Operating lease commitments 30,139,000 3,647,000 7,324,000 6,061,000 13,107,000
Other contractual purchase
Obligations - - - - -
Other long-term liabilities - - - - -
----------- ------------ ------------ ----------- -----------
Total $31,376,000 $ 4,008,000 $ 7,787,000 $ 6,422,000 $13,159,000
----------- ------------ ------------ ----------- -----------
(1) Excludes other long term liabilities of $7,398,000 at December 25, 2005 consisting of
tenant improvement allowances and deferred rents each of which is amortized over the life of
the respective leases.
29
COMMITMENTS RELATING TO MANAGED RESTAURANTS AND LLCS. We are party to
various arrangements by which we either manage restaurants or operate
restaurants in partnership with investors. Certain of these arrangements
include undertakings on our part to provide capital or financing or entail
certain guarantees on our part.
With respect to managed restaurants, we are typically contractually
obligated to pay operating expenses of those restaurants but funds necessary to
operate restaurants under management agreements are usually funded by cash
generated by the restaurant. Sales from these outlets are deposited directly
into an agency account belonging to the owner and we pay the outlet operating
expenses, including our fee, from this agency account.
The agreements and arrangements under which we may be required, as of
December 25, 2005, to make cash advances or contributions, guarantee obligations
or defer receipt of cash are:
CITYWALK. The CityWalk management agreement requires that each member
loan, interest free, to the joint venture 50 percent of any operating
deficit forecast for the next quarter, such loans to be repaid out of the
first cash available from operations. Each time funds were necessary, we
have agreed with our partner, to consider the advances additional capital
contributions rather than loans. As of December 25, 2005, we had made
additional capital contributions to the CityWalk Partnership of $296,000.
SAN FRANCISCO DAILY GRILL. The management agreement for the San
Francisco Daily Grill stipulates that if in any month there is insufficient
working capital to pay operating expenses, excluding payments to us or the
owner, we will provide one-half of the required working capital. Such
advances are to be repaid prior to deferred payments to us or the owner. No
working capital advances have been necessary.
PORTLAND DAILY GRILL. The management agreement for the Portland Daily
Grill stipulates that the Owner shall provide working capital of no less
than $50,000 or more than $150,000. If during any month there is
insufficient working capital to pay for operating expenses the Owner agreed
to advance the required working capital until the balance of the Owner
Working Capital Advance equals $150,000. Thereafter if additional working
capital is necessary we as the manager will be required to loan it. Any
advances we make will earn interest at a rate of 12% per annum and will be
repaid as second priority behind owner's working capital advance but before
owner's return of capital. At December 25, 2005 the owner had advanced
$150,000.
612 FLOWER DAILY GRILL (DOWNTOWN). The Operating Agreement for the 612
Flower Daily Grill, LLC stipulates that each member is entitled to a
preferred return on their capital contribution. If there is insufficient
working capital to pay for operating expenses both the minority member and
the Company shall provide a working capital additional capital contribution
up to a maximum of $100,000. No working capital additional capital
contributions have been necessary to date. We have also guaranteed the
fifteen-year lease for this restaurant.
CHICAGO - THE GRILL ON THE ALLEY. We have guaranteed the repayment of
the senior promissory note as well as the contributed capital for Chicago -
The Grill on the Alley totaling $904,000 at December 25, 2005. All amounts
guaranteed with respect to Chicago - The Grill on the Alley are reflected
on our balance sheet as liabilities. In March 2006, the amounts owing on
the senior promissory note were paid in full from funds provided under the
Company's credit faciltiy. For the next three years, on each anniversary of
the repayment the Company is required to make a $50,000 payment to the
holder of the note as an early termination payment.
Our San Jose Grill, Chicago - Grill on the Alley, Grill on Hollywood, South
Bay Daily Grill and Downtown Daily Grill restaurants are each owned by limited
liability companies (the "LLCs") for which we serve as manager and own a
controlling interest. Each of the LLCs has minority interest owners, some of
whom have participating rights in the joint venture such as the ability to
approve operating and capital budgets and the borrowing of money. In connection
with the financing of each of the LLCs, the minority members may have certain
rights to priority distributions of capital until they have received a return of
their initial investments ("Return of Member Capital") as well as rights to
receive defined preferred returns on their invested capital ("Preferred
Return").
30
Our Universal CityWalk Daily Grill is owned by a partnership for which we
serve as manager. Our partner has certain rights to priority distribution of
capital from the CityWalk partnership until they have received their initial
investments ("Return of Member Capital").
The principal distribution provisions with respect to each of the
restaurant LLCs and Partnerships are described below. In each instance, the
balance of distributable cash represents cash available for distribution to the
members after all obligations, including minimum working capital advances, have
been satisfied. The distribution provisions outlined below are consistent with
the order of distributions in a liquidation scenario and are utilized for
purposes of allocated profits and losses under the liquidation model described
elsewhere in this report.
SAN JOSE GRILL. Distributions from the San Jose Grill are allocated as
follows: (1) until the return of the initial capital contributions and any
additional capital contributions and preferred returns, (a) 10% to the
Company, as manager, and (b) 50.05% of 90% to the Company and 49.95% of 90%
to the investor members, and (2) thereafter, (a) 16.67% to the Company, as
manager, and (b) 50.05% of 83.33% to the Company and 49.95% to the investor
members.
CHICAGO - THE GRILL ON THE ALLEY. Distributions from Chicago - The
Grill on the Alley are allocated as follows: (1) until return of the
capital contributions and preferred return, 100% to the investor members,
and (2) thereafter, 40% to the Company and 60% to the investor members.
GRILL ON HOLLYWOOD. Distributions from Grill on Hollywood are
allocated as follows: (1) until the return of the investor member's initial
capital contributions, 10% to the Company, as manager, and 90% to the
investor members, (2) thereafter and until the return of the Company's
initial capital contributions, 90% to the Company and 10% to the investor
members, (3) thereafter and until return of the preferred returns, 10% to
the Company and 90% to the investor members, and (4) thereafter, 51% to the
Company and 49% to the investor members.
SOUTH BAY DAILY GRILL. Distributions from South Bay Daily Grill are
allocated as follows: (1) until payment in full of all deferred management
fees, 100% to the Company, as manager, (2) thereafter, until return of any
additional capital contributions, ratably between the Company and the
investor members based on total additional capital contributions, (3)
thereafter, until $300,000 of distributions are paid, 33.3% to the Company
and 66.67% to the investor members, (4) thereafter, until return of
investor member's preferred return, 10% to the Company and 90% to the
investor members, (5) thereafter, until the return of all investor member's
capital contributions, 10% to the Company and 90% to the investor members,
(6) thereafter, until return of the Company's preferred return, 90% to the
Company and 10% to the investor members, (7) thereafter, until return of
all of the Company's capital contributions, 90% to the Company and 10% to
the investor members, and (8) thereafter, 50.1% to the Company and 49.9% to
the investor members.
UNIVERSAL CITYWALK DAILY GRILL. Distributions from Universal CityWalk
Daily Grill are allocated as follows: (1) until return of additional
capital contributions 50% to the Company and 50% to the partner, (2) the
next $550,000 to the partner, (3) then until unpaid preferred return is
paid in full 100% to the partner, (4) then 80% to the partner and 20% to
the Company until return of initial capital contribution and (5)
thereafter, 50% to the Company and 50% to the partner.
DOWNTOWN DAILY GRILL. Distributions from Downtown Daily Grill are
allocated as follows: (1) until return of all initial capital
contributions, (a) 10% to the Company, as manager, and (b) 15.03% to the
Company, as a member, and 74.97% to the investor members, (2) thereafter,
until the return of all additional capital contributions, ratably among the
Company and the investor members based on their additional capital
contributions, (3) thereafter, until repayment of long term working capital
loans by the Company, 100% to the Company, and (4) thereafter, (a) 8.335%
to the Company, as manager, and (b) 50% to the Company, as a member, and
41.665% to the investor members.
The following tables set forth a summary for each of the LLCs and the
partnership of (1) the initial capital contributions of the Company and the
minority LLC members or partner (the "Members"), (2) additional capital
contributions, (3) the distributions of capital to the Members and/or us during
the year ended December 25, 2005, (4) the unreturned balance of the capital
contributions of the Members and/or us at December 25, 2005, (5) the Preferred
Return rate to Members and/or us, (6) the accrued but unpaid preferred returns
due to the Members and/or us at December 25, 2005, and (7) the management
incentive fees, if any, payable to us.
31
SAN JOSE CHICAGO GRILL ON THE ALLEY THE GRILL ON HOLLYWOOD LLC
-------- -------------------------- --------------------------
Members Company Members Company Members Company
Initial Capital
Contribution: $1,149,650 $350,350 $1,700,000(b) $ - $1,200,000 $250,000
=========== ========= ============= ========= =========== ========
Distributions of profit
and note repayments
during the year ended
December 25, 2005: $ 228,000 $228,000 $ 252,000 $ - - -
=========== ========= ============= ========= =========== ========
Unreturned Initial
Capital Contributions at
December 25, 2005: $ - $ - $ 904,000 $ - $1,200,000 $250,000
=========== ========= ============= ========= =========== ========
Preferred Return rate: 10% 10% 8% 12% 12%
=========== ========= ============= ========= =========== ========
Accrued but unpaid
Preferred Returns at
December 25, 2005: $ - $ - $ - (d) (d)
=========== ========= ============= ========= =========== ========
Management Fee: 5% 5% 5%
=========== ========= ============= ========= =========== ========
SOUTH BAY DAILY GRILL DOWNTOWN DAILY GRILL
--------------------- --------------------
(CONTINENTAL PARK LLC) UNIVERSAL CITYWALK DAILY GRILL (612 FLOWER DAILY GRILL, LLC)
---------------------- ------------------------------ -----------------------------
Members Company Members Company Members Company
(e)
Initial Capital
Contribution: $1,000,000 $350,000 $1,100,000 - $1,375,000 $275,000
=========== ========= =========== ======== =========== =========
Additional capital
contributions - $100,000 $ 296,106 $296,106 - -
=========== ========= =========== ======== =========== =========
Distributions of profit
during the year ended
December 25, 2005: - - - - - -
=========== ========= =========== ======== =========== =========
Unreturned Initial and
Additional Capital
Contributions at
December 25, 2005: $1,000,000 $350,000 $1,396,106 $296,106 $1,375,000 $275,000
=========== ========= =========== ======== =========== =========
Preferred Return rate: 10% 10% (c) - - 9% 9%
=========== ========= =========== ======== =========== =========
Accrued but unpaid
Preferred Returns at
December 25, 2005: (d) (d) (d) - $ 72,254 $ 18,584
=========== ========= =========== ======== =========== =========
Management Fee: 5% 5% 5%
=========== ========= =========== ======== =========== =========
32
(a) The initial capital contributions of the Members of San Jose
Grill LLC consisted of a capital contribution of $349,650 and a loan
of $800,000.
(b) The initial capital contributions of the Members of Chicago -
Grill on the Alley LLC consisted of a capital contribution of $1,000
and a loan of $1,699,000. $1,189,000 of the loan was converted to
capital in 1999. Under the terms of the joint venture agreement, the
LLC is obligated to repay both the converted capital and loan and the
Company guaranteed the joint venture's payment of these obligations.
Distributions of capital and note repayments for the year ended
December 25, 2005 includes $172,000 of capital and note repayments and
$80,000 of interest and preferred return. No losses are allocated to
the minority interest partner as the investor has no equity at risk.
The loan of $1,699,000 is reflected on the balance sheet as notes
payable-related parties.
(c) The Company's preferred return with respect to the South Bay
Daily Grill is based on unrecovered capital contribution and accrued
but unpaid management fees.
(d) Due to the poor performance of the restaurant the preferred
return is not being accrued. The Company is not liable to pay the
preferred return distributions, such that they represent a
non-recourse obligation of the subsidiary entity. If preferred returns
were accrued for The Grill on Hollywood the Member would have an
accrued preferred return of $766,000 and the Company would have an
accrued preferred return of $160,000. If preferred returns were
accrued for South Bay Daily Grill the Member would have an accrued
preferred return of $353,000 and the Company would have an accrued
preferred return of $137,000. If preferred returns were accrued for
the CityWalk Partnership the Member would have an accrued return of
$528,000.
(e) The Company is a non-managing member and a wholly owned
subsidiary of the Company is the Manager of this restaurant.
OFF-BALANCE SHEET ARRANGEMENTS. At December 25, 2005, we had no
off-balance sheet arrangements of the nature described in Item 303(a)(4) of
Regulation S-K.
CAPITAL EXPENDITURES. Management anticipates that new non-hotel based
restaurants will cost between $1 million and $3 million per restaurant to build
and open depending upon the size, location and available tenant allowances.
Hotel based restaurants may involve remodeling existing facilities, substantial
capital contributions from the hotel operators and other factors which will
cause the cost to us of opening such restaurants to be less than our cost to
build and open non-hotel based restaurants.
Capital expenditures were $1.4 million in 2003, $2.9 million in 2004 and
$3.7 million in 2005. Capital expenditures in fiscal 2006 are expected to be
between $0.8 million and $4.0 million, primarily for the development of new
restaurants, capital replacements and refurbishing existing restaurants. The
amount of actual capital expenditures will be dependent upon, among other
things, the proportion of free standing versus hotel based properties as hotel
based restaurants are expected to generally require lower capital investment on
our part. In addition, if we open more, or less, restaurants than we currently
anticipate, our capital requirements will increase, or decrease, accordingly.
33
In September 2005 we signed a lease for a owned Grill restaurant in Dallas,
Texas. The restaurant began construction in February 2006 and is expected to
open in the summer of 2006. Construction of the restaurant is being paid for
through a $2.0 million tenant improvement allowance, equipment financing and
existing cash.
CONVERTIBLE SECURITIES AND WARRANTS. We previously issued various
convertible securities, warrants and common stock to finance restaurant openings
in 1997 and 1998. 500 shares of Series II 10% Convertible Preferred Stock
issued in that transaction remained outstanding at December 25, 2005. All
warrants issued in that transaction expired in 2002.
The Series II 10% Convertible Preferred Stock is convertible into common
stock commencing one year from the date of issuance at the greater of (i) $4.00
per share, or (ii) 75% of the average closing price of our common stock for the
five trading days immediately prior to the date of conversion; provided,
however, that the conversion price shall in no event exceed $10.00 per share.
The Series II 10% Convertible Preferred Stock is entitled to receive an annual
dividend equal to $100 per share payable on conversion or redemption in cash or,
at our option, in common stock at the then applicable conversion price. The
Series II Convertible Preferred Stock is subject to redemption, in whole or in
part, at our option on or after the second anniversary of issuance at $1,000 per
share. Accrued dividends in arrears total $426,000 at December 25, 2005 and
$376,000 at December 26, 2004.
In 1999, in connection with the funding and opening of the Chicago - The
Grill on the Alley, we issued a series of warrants to the member investor of
Chicago - The Grill on the Alley consisting of (1) 177,083 warrants exercisable
at $4.00 per share which expired in 2005; (2) 17,708 warrants exercisable at
$4.00 per share if and when we exercise the first renewal option on the
restaurant lease and expire in June 2010; and (3) 8,854 warrants exercisable at
$4.00 per share if and when we exercise the second renewal option on the
restaurant lease and expire in June 2015.
In 2000, in connection with a loan from two entities controlled by an
individual that subsequently became a director of the Company, we issued 40,000
warrants exercisable at $1.406 per share and expiring in June 2005. Those
warrants were exercised in 2004 pursuant to cashless exercise provisions
contained in the warrants and resulted in the issuance of 15,920 shares of
common stock. In July 2001, an additional 32,058 warrants exercisable at $2.77
per share were issued in connection with the loan. Those warrants were
exercised in 2005 pursuant to cashless exercise provisions contained in the
warrants and resulted in the issuance of 6,154 shares of common stock.
In 2000, in connection with guarantees of our bank lending facility, we
issued 150,000 warrants to two of our directors who are also principal
shareholders. The warrants were exercisable at $1.406 per share and expire in
June 2005. Those warrants were exercised in 2004 pursuant to cashless exercise
provisions contained in the warrants and resulted in the issuance of 82,562
shares of common stock. In 2001, an additional 150,000 warrants exercisable at
$2.12 per share were issued in connection with the guarantee. Those warrants
were exercised in 2005 pursuant to cashless exercise provisions contained in the
warrants and resulted in the issuance of 58,995 shares of common stock.
In July 2001, we completed a transaction with Starwood Hotels and Resorts
Worldwide, Inc. pursuant to which we sold 666,667 shares of restricted common
stock and 666,667 stock purchase warrants exercisable at $2.00 to Starwood for
$1,000,000. Concurrently, we sold an additional 666,666 shares of restricted
common stock and 666,666 stock purchase warrants exercisable at $2.25 to other
strategic investors for $1,000,000. All warrants issued in the transaction
expire in July 2006.
STARWOOD ALLIANCE
In conjunction with the July 2001 investment by Starwood, we and Starwood
entered into a Development Agreement under which we and Starwood agreed to
jointly develop our restaurant properties in Starwood hotels.
Under the Starwood Development Agreement, either we or Starwood may propose
to develop a Daily Grill, Grill or City Bar and Grill restaurant in a Starwood
hotel property. If the parties agree in principal to the development of a
restaurant, the parties will attempt to negotiate either a management agreement
or a license agreement with respect to the operation of the restaurant.
34
Under the Development Agreement, we are obligated to issue to Starwood
warrants to acquire a number of shares of our common stock equal to four percent
of the outstanding shares upon the attainment of certain development milestones.
Such warrants are issuable upon execution of management agreements and/or
license agreements relating to the development and operation, and the
commencement of operation, of an aggregate of five, ten, fifteen and twenty of
our branded restaurants. If the market price of our common stock on the date
the warrants are to be issued is greater than the market price on the date of
the Development Agreement, the warrants will be exercisable at a price equal to
the greater of (1) 75% of the market price as of the date such warrant becomes
issuable, or (2) the market price on the date of the Development Agreement. If
the market price of our common stock on the date the warrants are to be issued
is less than the market price on the date of the Development Agreement, the
warrants will be exercisable at a price equal to the market price as of the date
such warrants become issuable. The warrants will be exercisable for a period of
five years.
In addition to the warrants described above, if and when the aggregate
number of restaurants operated under the Development Agreement exceeds 35% of
the total Daily Grill, Grill and City Grill-branded restaurants, we will be
obligated to issue to Starwood a warrant to purchase a number of shares of our
common stock equal to 0.75% of the outstanding shares on that date exercisable
for a period of five years at a price equal to the market price at that date.
On each anniversary of that date at which the restaurants operated under the
Development Agreement continues to exceed the 35% threshold, for so long as the
Development Agreement remains effective, we shall issue to Starwood additional
warrants to purchase 0.75% of the outstanding shares on that date at an exercise
price equal to the market price on that date.
Following the events of September 11, 2001, Starwood substantially
curtailed new development activities and only two management agreements have, as
yet, been entered into under the Development Agreement. The exclusivity
portions of the agreement have terminated due to the lack of performance on
Starwood's part.
SHORT-TERM FINANCING REQUIREMENTS
Management believes that we have adequate resources on hand and operating
cash flow to sustain operations for at least the following 12 months through
March 2007. We project increased operating cash flows in 2006 which, when added
to existing cash balances, will allow us to meet all operating, investing and
financing needs. Such projections are based on sales increases due to store
openings, as well as modest increases in same store sales. In the event of a
decline in sales, as a result of deterioration of the economy or the hospitality
industry or other factors, management believes it can respond to such a decrease
in sales through cost controls, reductions in discretionary capital improvements
and borrowings under the existing credit facility. In order to fund the opening
of additional restaurants, we might require additional capital that might be
raised through the issuance of debt or equity securities, or the formation of
additional investment/loan arrangements, or a combination thereof. In March
2006 we obtained a new line of credit to fund future growth. The new line
provides a revolving term loan of the lesser of $8 million or 2.25 times the
trailing twelve month EBITDA with interest only payments at approximately 10.5%
with a maturity of March 10, 2011. We are currently in discussions regarding
several potential restaurant locations however, other than our planned opening
of a Grill in Dallas, Texas, as of March 15, 2006, we had no commitments to
lease additional space or open additional restaurants. See "Business --
Business Expansion" and "Management's Discussion and Analysis -- Certain Factors
Affecting Future Operating Results."
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of
operations are based upon our financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our financial
statements.
PRINCIPALS OF CONSOLIDATION AND MINORITY INTERESTS. Our restaurant
operations are conducted through multiple wholly-owned subsidiaries as well as
through five majority-owned limited liability companies and through a 50% owned
joint venture. Our consolidated financial statements include balance sheet and
income statement items, after eliminating inter-company accounts and
transactions, of each wholly-owned and majority-owned subsidiary and entities
35
consolidated under FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51" ("FIN 46"). The allocated
interest of the earnings or loss of majority-owned subsidiaries attributable to
the minority owners of those subsidiaries is reflected in a single statement of
operations entry, with minority interests in earnings being a reduction in net
income and minority interests in losses being an increase in net income. The
proportionate interest in the equity of majority-owned subsidiaries attributable
to the minority owners of those subsidiaries is reflected as a single balance
sheet entry between liabilities and stockholders' equity.
We allocate profits and losses to the minority interest in our
majority-owned subsidiaries based on the underlying economics of the investment.
These may or may not reflect our ownership percentage and can be inconsistent
with the allocation provisions specified in the joint venture agreements. Where
there is a disparity among the ownership percentages, the terms of the
agreements and the underlying economics, we utilize a hypothetical liquidation
model to allocate profits and losses. Under this model, all of the ventures'
assets and liabilities as reflected in the balance sheet are assumed to be
realized at their GAAP carrying values. The hypothetical liquidating proceeds
are calculated at the end of each period and applied to the capital accounts as
would occur under a true liquidation scenario. The change in this balance from
period to period represents the investors' share of the income or loss.
Under FIN 46, an entity is considered to be a variable interest entity
("VIE") when it has equity investors which lack the characteristics of a
controlling financial interest, or its capital is insufficient to permit it to
finance its activities without additional subordinated financial support.
Consolidation of a VIE by an investor is required when it is determined that the
investor is the primary beneficiary and will absorb a majority of the VIE's
expected losses or residual returns if they occur.
Management has assessed all entities which are not wholly owned by us to
determine if these entities would be considered VIEs and whether we would be
considered the primary beneficiary. It was determined that all of the following
entities would be considered VIEs: The San Jose Grill LLC, Chicago - The Grill
on the Alley LLC, The Grill on Hollywood LLC, The Daily Grill at Continental
Park LLC, 612 Flower Daily Grill LLC and the Universal CityWalk Daily Grill
joint partnership. We determined that we are the primary beneficiary for all
these entities.
IMPAIRMENT OF LONG-LIVED ASSETS. We review all long-lived assets on a
regular basis to determine if there has been impairment in the value of those
assets. If, upon review, it is determined that the carrying value of those
assets may not be recoverable, we will record a charge to earnings and reduce
the value of the asset on the balance sheet to the amount determined to be
recoverable.
For purposes of evaluating recoverability of long-lived assets, the
recoverability test is performed using undiscounted cash flows of the individual
restaurants and consolidated undiscounted net cash flows for long-lived assets
not identifiable to individual restaurants compared to the related carrying
value. If the undiscounted operating income is less than the carrying value,
the amount of the impairment, if any, will be determined by comparing the
carrying value of each asset with its fair value. Fair value is generally based
on a discounted cash flow analysis.
Based on our review of our presently operating restaurants and other
long-lived assets, during the fiscal year ended December 25, 2005, we recorded
no impairments of our long-lived assets.
VALUATION OF ACCOUNTS RECEIVABLE. We review all of our accounts receivable
on a regular basis to determine the collectability of each account based on age,
response to collection efforts, and other factors. We establish a reserve for
those accounts where collection seems doubtful. If a determination is made that
the customer will definitely not pay, the amount is written off against the
reserve.
Based on our review at December 25, 2005, the current reserve for
uncollectable accounts receivable is adequate.
RECORDING REIMBURSABLE COSTS.We operate a number of restaurants under
management agreements whereby we are responsible for all aspects of restaurant
operation. For our services, we typically receive a management fee based on a
percentage of revenue and an incentive fee which is usually a profit sharing
arrangement. Under the terms of the management agreements, we are hired as an
36
independent contractor and are responsible for all debts and liabilities of the
restaurant. Additionally, all employees are employees of Grill Concepts, not
the individual restaurant. Although payroll and other operating expenses are
paid out of an agency bank account belonging to the restaurant, based on the
weight of the indicators identified in EIFT 01-14,"Income Statement
Characterization of Reimbursements Received for 'Out of Pocket' Expenses
Incurred," and EITF 99-19,"Reporting Revenue Gross as a Principal Versus Net as
an Agent," we consider ourselves the primary obligor in these arrangements.
Accordingly, we recognize restaurant expenses of the managed outlets in our
financial statements and record the reimbursement for such expenses as revenues.
HRP. The Company is party to mirroring put and call options whereby HRP
has the right to require the Company to buy HRP and the Company has the right to
buy HRP on substantially identical terms. The Company concluded that the
options relating to HRP would be defined as a derivative under FAS 133.
However, because the purchase price was based on a floating price, it was
determined that the value of the put and call would be identical so long as the
formula resulted in a representative fair value of HRP.
The Company concluded that the multiple was based on fair value because the
original formula was negotiated between two parties. This fact was reconfirmed
when the HRP agreement was amended approximately three years later at the time
the Company entered into a development agreement with Starwood Hotels and the
multiple for the HRP put and call options did not change. We believe the
multiple used in the formula to be within a tolerable range of those found in
the marketplace. Therefore, management believes that the formula is a reasonable
approximation of fair value of the HRP business that results in the put and call
options having similar values. Additionally, because fair market puts and calls
have little value on their own, any asset and liability related to these would
be insignificant. No derivative accounting is necessary in these circumstances
and therefore, no accounting recognition has been made in the financial
statements.
The Company will continue to evaluate the appropriateness of formula to
market conditions to ensure it represents fair market value, and will continue
to evaluate the formula going forward and to the extent it no longer represents
fair market value, will account for the derivative appropriately.
CERTAIN FACTORS AFFECTING FUTURE OPERATING RESULTS
This Form 10-K contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Our actual results could differ materially from those set
forth in the forward-looking statements. Certain factors that might cause such
a difference include the following: adverse weather conditions and other
conditions affecting agricultural output which may cause shortages of key food
ingredients and volatility of food prices and which, in turn, may reduce
operating margins; changes in consumer tastes, demographics and adverse economic
conditions which may result in reduced frequency of dining at our restaurants;
the dependence on key personnel and ability to attract and retain qualified
management and restaurant personnel to support existing operations and future
growth; regulatory developments, particularly relating to labor matters (i.e.,
minimum wage, health insurance and other benefit requirements), health and
safety conditions, service of alcoholic beverages and taxation, which could
increase the cost of restaurant operations; establishment of market position and
consumer acceptance in new markets in light of intense competition in the
restaurant industry and the geographic separation of senior management from such
markets; potential delays in securing sites for new restaurants and delays in
opening restaurants which may entail additional costs and lower revenues than
would otherwise exist in the absence of such delays; the availability of capital
to fund future restaurant openings; rising energy costs and the occurrence of
rolling blackouts in California which may result in higher occupancy costs and
periodic restaurant closures; and, other risks described more fully in "Risk
Factors" beginning on page 15.
NEW ACCOUNTING REQUIREMENTS
In June 2005, the EITF issued EITF Issue No. 05-06, "Determining the
Amortization Period for Leasehold Improvements Purchased after Lease Inception
or Acquired in a Business Combination" ("EITF 05-06"). EITF 05-06 provides that
the amortization period for leasehold improvements acquired in a business
combination or purchased after the inception of a lease be the shorter of (a)
the useful life of the assets or (b) a term that includes required lease periods
37
and renewals that are reasonably assured upon the acquisition or the purchase.
The provision of EITF 05-06 are effective for leasehold improvements purchased
or acquired beginning July 2005. The adoption of EITF 05-06 did not have a
material impact on the Company's consolidated financial statements.
In October 2005, the FASB posted FASB Staff Position (FSP) 13-1, which
requires that rental costs incurred during and after a construction period for
the right to control the use of a leased asset during and after construction of
a lessee asset to be recognized as rental expense. The provisions of FSP 13-1
shall be applied to the first reporting period beginning after December 15,
2005. The Company's existing accounting policy for rental costs incurred during
and after the construction period conforms to FSP 13-1. The adoption of FSP
13-1 will not have a material impact on the Company's consolidated financial
statements.
In April 2004, the EITF reached final consensus on EITF 03-06,
"Participating Securities and the Two-Class Method under FASB Statement No.
128," which requires companies that have participating securities to calculate
earnings per share using the two-class method. This method requires the
allocation of undistributed earnings to the common shares and participating
securities based on the proportion of undistributed earnings that each would
have been entitled to had all the period's earnings been distributed. EITF 03-06
is effective for fiscal periods beginning after March 31, 2004 and earnings per
share reported in prior periods presented must be retroactively adjusted in
order to comply with EITF 03-06. The Company adopted EITF 03-06 for the quarter
ended June 27, 2004, however there has been no impact on the Company's financial
statements as the preferred shares are not participating securities.
On December 16, 2004, the Financial Accounting Standards Board (FASB)
issued FASB Statement No. 123 (revised 2004), Share-Based Payment, which is a
revision of FASB Statement No. 123, Accounting for Stock-Based Compensation.
Statement 123(R) supersedes APB No. 25, and amends FASB Statement No. 95,
Statement of Cash Flows. Generally, the approach in Statement 123(R) is similar
to the approach described in Statement 123. However, Statement 123(R) requires
all share-based payments to employees, including grants of employee stock
options, to be recognized in the statement of operations based on their fair
values. Pro forma disclosure is no longer an alternative.
As permitted by Statement 123, we currently account for share-based
payments to employees using APB No. 25's intrinsic value method and, as such,
generally recognize no compensation cost for employee stock options.
Accordingly, the adoption of Statement 123(R)'s fair value method may have a
significant impact on our result of operations, although it will have no impact
on our overall financial position. The impact of adoption of Statement 123(R)
cannot be predicted at this time because it will depend on levels of share-based
payments granted in the future. However, had we adopted Statement 123(R) in
prior periods, the impact of that standard would have approximated the impact of
Statement 123 as described in the disclosure of pro forma net income and
earnings per share above.
We expect to adopt Statement 123(R) in the first quarter of 2006.
IMPACT OF INFLATION
Substantial increases in costs and expenses, particularly food, supplies,
labor and operating expenses, could have a significant impact on our operating
results to the extent that such increases cannot be passed along to customers.
We do not believe that inflation has materially affected our operating results
during the past two years.
A majority of our employees are paid hourly rates related to federal and
state minimum wage laws and various laws that allow for credits to that wage.
Our cost of operations have been affected by several increases in the Federal
and State minimum wage in recent years. In addition, further increases in the
minimum wage are also being discussed by the federal and various state
governments. Although we have been able to and will continue to attempt to pass
along increases in costs through food and beverage price increases, there can be
no assurance that all such increases can be reflected in our prices or that
increased prices will be absorbed by customers without diminishing, to some
degree, customer spending at its restaurants.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates on funded
debt. This exposure relates to our credit line facility. At December 25, 2005
there are no borrowings under the credit line. Borrowings under the credit
facility bear interest at the lender's prime rate. A hypothetical 1% interest
rate change would not have a material impact on our results of operations.
38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements, together with the reports of
independent registered public accounting firms appear herein. See Index to
Financial Statements on page F-1 immediately following the signature page of
this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. We maintain disclosure controls and
procedures (as defined in Exchange Act Rule 13a-15(e) and 15d-15(e)) that are
designed to ensure that information required to be disclosed in our reports
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms, and that such information is accumulated and
communicated to management, including our Chief Executive Officer ("CEO") and
Chief Financial Officer ("CFO"), as appropriate, to allow timely decisions
regarding required disclosure.
In designing and evaluating the disclosure controls and procedures, our
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, as ours are designed to do, and our management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
In connection with the preparation of this Annual Report on Form 10-K, as
of December 25, 2005, an evaluation was performed under the supervision and with
the participation of our management, including the CEO and CFO, of the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Exchange Act).
Based on the totality of the aforementioned, we concluded that our
disclosure controls and procedures were effective as of December 25, 2005.
Change in Internal Control Over Financial Reporting. There were no changes
in our internal control over financial reporting that occurred during our last
fiscal quarter that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
Not applicable.
39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item will be included in a definitive
proxy statement, pursuant to Regulation 14A, to be filed not later than 120 days
after the close of our fiscal year. Such information is incorporated herein by
reference.
Information with respect to our executive officers is included in Part I.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item will be included in a definitive
proxy statement, pursuant to Regulation 14A, to be filed not later than 120 days
after the close of our fiscal year. Such information is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
The information required by this Item will be included in a definitive
proxy statement, pursuant to Regulation 14A, to be filed not later than 120 days
after the close of our fiscal year. Such information is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be included in a definitive
proxy statement, pursuant to Regulation 14A, to be filed not later than 120 days
after the close of our fiscal year. Such information is incorporated herein by
reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this Item will be included in a definitive
proxy statement, pursuant to Regulation 14A, to be filed not later than 120 days
after the close of our fiscal year. Such information is incorporated herein by
reference.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
The following documents are filed as a part of this Report:
(1) Consolidated Financial Statements: See Index to Financial Statements
on page F-1 of this report for financial statements and supplementary data filed
as part of this report.
(2) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts and Allowances
(3) Exhibits
Exhibit
Number Description of Exhibit
------ ------------------------
3.1 Certificate of Incorporation, as amended, of Grill Concepts, Inc. (3)
3.2 Certificate of Amendment to Restated Certificate of Incorporation
of Grill Concepts, Inc. (4)
3.3 Certificate of Amendment to Restated Certificate of Incorporation of
Grill Concepts, Inc. dated August 1999 (8)
3.4 Certificate of Amendment of Restated Certificate of Incorporation of
Grill Concepts, Inc., dated July 3, 2001 (15)
3.5 Bylaws, as amended, of Grill Concepts, Inc. (1)
3.6 Amendment to Bylaws of Magellan Restaurant Systems, Inc. dated
December 31, 1994 (2)
4.1 Certificate of Designation fixing terms of Series II Preferred
Stock (4)
40
4.2 Specimen Common Stock Certificate (1)
10.1 Operating Agreement for San Jose Grill LLC, dated June 1997 (5)
10.2 Amendment, dated December 1997, to Operating Agreement for San
Jose Grill LLC (5)
10.3 Blanket Conveyance, Bill of Sale and Assignment between Grill
Concepts, Inc. and Air Terminal Services, Inc. (6)
10.4 License Agreement between Grill Concepts, Inc. and Airport Grill,
L.L.C. (6)
10.5 Agreement, dated August 27, 1998, between Grill Concepts, Inc. and
Hotel Restaurant Properties, Inc. (6)
10.6 Restaurant Management Agreement between Grill Concepts, Inc.,
Hotel Restaurant Properties, Inc. and CapStar Georgetown Company,
L.L.C. for the Georgetown Inn (6)
10.7 Loan Agreement between Grill Concepts, Inc. and The Wolff
Revocable Trust of 1993 (7)
+10.8 Grill Concepts, Inc. 1998 Comprehensive Stock Option and Award
Plan, as amended February 27, 2001 (9)
10.9 Chicago - Grill on the Alley First Extension Warrant (10)
10.10 Chicago - Grill on the Alley Second Extension Warrant (10)
10.11 Guaranty - Michigan Avenue Group Note (10)
10.12 Operating Agreement for Chicago - The Grill on the Alley LLC (10)
10.13 Indemnification Agreement between Grill Concepts, Inc., Lewis N.
Wolff and the Lewis N. Wolff Revocable Trust of 1993 and Michael S.
Weinstock and Michael S. Weinstock Trustee of the Michael S. Weinstock
Living Trust (11)
10.14 Form of Letter Agreement regarding Loan Facility (11)
10.15 Form of four year 9% Promissory Note (11)
10.16 Form of Warrant issued in connection with Promissory Notes (11)
10.17 Guarantee Agreement dated July 11, 2000 with Michael Weinstock
and Lewis Wolff (11)
10.18 Form of Warrant issued in connection with Loan Guaranty (11)
10.19 Michael Grayson Warrant (14)
10.20 Daily Grill Restaurant Management Agreement, dated February 5, 2001,
between Grill Concepts Management, Inc., Hotel Restaurant Properties
II Management, Inc., and Handlery Hotel, Inc. (12)
10.21 Subscription Agreement, dated May 16, 2001, by and between Grill
Concepts, Inc. and Starwood Hotels & Resorts Worldwide, Inc. (14)
10.22 Development Agreement by and between Grill Concepts, Inc. and
Starwood Hotels & Resorts Worldwide, Inc. (14)
10.23 Investor Rights Agreement by and between Grill Concepts, Inc. and
Starwood Hotels & Resorts Worldwide, Inc. (14)
10.24 Stockholders' Agreement by and between Grill Concepts, Inc.,
Starwood Hotels & Resorts Worldwide, Inc., Robert Spivak, Michael
Weinstock, Lewis Wolff, Keith Wolff and Wolff Revocable Trust of
1993. (13)
10.25 Form of $2.00 Warrant. (14)
10.26 Amendment to Hotel Restaurant Properties, Inc. Agreement, dated
July 27, 2001 (15)
+10.27 Employment Agreement, dated January 1, 2004, with Robert Spivak (17)
+10.28 Consulting Agreement with Robert Spivak (17)
+10.29 Employment Agreement, dated June 22, 2004, with Philip Gay (18)
+10.30 Form of Stock Option Agreement (19)
10.31 Change of Control Severance Agreement Form (20)
10.32 Credit Agreement, dated as of March 10, 2006, between Grill
Concepts, Inc. and Diamond Creek Investment Partners, LLC (21)
10.33 Fee Letter, dated March 10, 2006, between Grill Concepts, Inc.
and Diamond Creek Investment Partners LLC (21)
+10.34 Employment Agreement, effective March 3, 2006, with
Philip Gay (22)
14.1 Code of Business Ethics - CEO and Senior Financial Officers (16)
14.2 Code of Ethics (16)
21.1* Subsidiaries of Registrant
23.1* Consent of Moss Adams LLP
23.2* Consent of PricewaterhouseCoopers LLP
31.1* Section 302 Certification of CEO
41
31.2* Section 302 Certification of CFO
32.1* Certification of CEO Pursuant to 18.U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2* Certification of CFO Pursuant to 18.U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
+ Compensatory plan or management agreement.
* Filed herewith
(1) Incorporated by reference to the respective exhibits filed with
Registrant's Registration Statement on Form SB-2 (Commission File No.
33-55378-NY) declared effective by the Securities and Exchange Commission
on May 11, 1993.
(2) Incorporated by reference to the respective exhibits filed with
Registrant's Registration Statement on Form S-4 (Commission File No. 33-
85730) declared effective by the Securities and Exchange Commission on
February 3, 1995.
(3) Incorporated by reference to the respective exhibits filed with
Registrant's Registration Statement on Form SB-2 (Commission File No.
33-55378-NY) declared effective by the Securities and Exchange Commission
on May 11, 1993 and the exhibits filed with the Registrant's Current Report
on Form 8-K dated March 3, 1995.
(4) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 10-QSB for the quarter ended June 29, 1997.
(5) Incorporated by reference to the respective exhibits filed with the
Registrant's Annual Report on Form 10-KSB for the year ended December 28,
1997.
(6) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 10-QSB for the quarter ended September 27, 1998.
(7) Incorporated by reference to the respective exhibits filed with the
Registrant's Annual Report on Form 10-K for the year ended December 27,
1998.
(8) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 10-Q for the quarter ended June 27, 1999.
(9) Incorporated by reference to the Company's Definitive Proxy Statement
filed May 29, 2001.
(10) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 10-K for the year ended December 26, 1999.
(11) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 10-Q for the quarter ended September 24, 2000.
(12) Incorporated by reference to the respective exhibits filed with the
Registrant's Annual Report on Form 10-K for the year ended December 31,
2000.
(13) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 10-Q for the quarter ended April 1, 2001.
(14) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 8-K dated May 16, 2001.
(15) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 10-Q for the quarter ended July 1, 2001.
(16) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 10-K for the year ended December 28, 2003.
(17) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 10-Q for the quarter ended March 28, 2004.
(18) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 10-Q for the quarter ended June 27, 2004.
(19) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 8-K dated August 8, 2005.
(20) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 10-Q for the quarter ended September 25, 2005.
(21) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 8-K dated March 10, 2006.
(22) Incorporated by reference to the respective exhibits filed with the
Registrant's Form 8-K dated March 13, 2006.
42
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
GRILL CONCEPTS, INC.
By: /s/ Robert Spivak
------------------------
Robert Spivak
President
Dated: April 3, 2006
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Robert Spivak President, Chief Executive Officer April 3, 2006
----------------------- and Director (Principal Executive
Robert Spivak Officer)
/s/ Michael Weinstock Chairman of the Board of Directors April 3, 2006
----------------------- and Executive Vice President
Michael Weinstock
/s/ Bruce Schwartz Director April 3, 2006
-----------------------
Bruce Schwartz
/s/ Glenn Goldnberg Director April 3, 2006
-----------------------
Glenn Golenberg
/s/ Richard Dantas Director April 3, 2006
-----------------------
Richard Dantas
/s/ Stephen Ross Director April 3, 2006
-----------------------
Stephen Ross
/s/ Lewis Wolff Director April 3, 2006
-----------------------
Lewis Wolff
/s/ Philip Gay Chief Financial Officer April 3, 2005
----------------------- (Principal Accounting Officer and
Philip Gay Principal Financial Officer)
43
Grill Concepts, Inc. and Subsidiaries
Schedule II
VALUATION AND QUALIFYING ACCOUNTS AND ALLOWANCES
Allowance for Doubtful Accounts:
Balance at Additions Balance
Beginning Charged to Net At End
Of Year Operations Deductions Of Year
Year Ended
December 28, 2003 $ 46,000 $ 29,000 $ 62,000 $ 13,000
December 26, 2004 $ 13,000 $ 134,000 $ 4,000 $143,000
December 25, 2005 $143,000 $ 95,000 - $238,000
Valuation Allowance for Deferred Taxes:
Balance at Additions Balance
Beginning Charged to Net At End
Of Year Operations Deductions Of Year
Year Ended
December 28, 2003 $3,472,000 $ 76,000 $ - $3,548,000
December 26, 2004 $3,548,000 $ 22,000 $ - $3,570,000
December 25, 2005 $3,570,000 $ 497,000 $ 719,000 $3,348,000
44
GRILL CONCEPTS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS F-2
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 25, 2005 AND DECEMBER 26, 2004 F-5
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 25, 2005, DECEMBER 26, 2004 F-6
AND DECEMBER 28, 2003
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 25, 2005, DECEMBER 26, 2004 F-7
AND DECEMBER 28, 2003
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 25, 2005, DECEMBER 26, 2004 F-8
AND DECEMBER 28, 2003
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-9
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of
Grill Concepts, Inc.
We have audited the accompanying consolidated balance sheet of Grill Concepts,
Inc. and subsidiaries as of December 25, 2005 and December 26, 2004 and the
related consolidated statements of operations, stockholders' equity and cash
flows for the years then ended. Our audit also included the financial statement
schedule listed in Item 15(2) for the years ended December 25, 2005 and December
26, 2004. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Grill
Concepts, Inc. and subsidiaries as of December 25, 2005 and December 26, 2004,
and the consolidated results of their operations and their cash flows for the
years then ended, in conformity with U.S. generally accepted accounting
principles.
Moss Adams, LLP
Los Angeles, California
March 31, 2006
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Of Grill Concepts, Inc.
In our opinion, the consolidated statements of operations, of stockholders'
equity and of cash flows for the year ended December 28, 2003 referred to under
Item 15(a)(1) and listed in the index appearing on page F-1, present fairly, in
all material respects, the results of operations and cash flows of Grill
Concepts, Inc. and its subsidiaries for the year ended December 28, 2003 in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule as of and
for the year ended December 28, 2003 listed in the index appearing under Item
15(a)(2) presents fairly, in all material respects, the information set forth
therein when read in conjunction with the related consolidated financial
statements. These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and financial statement schedule based on
our audit. We conducted our audit of these statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
As discussed in Note 2 to the accompanying consolidated financial statements,
the Company adopted the provisions of Financial Accounting Standards Board
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51," (FIN 46) effective December 29, 2003, and has
applied the retroactive adoption provisions of FIN 46 in these consolidated
annual financial statements.
PricewaterhouseCoopers LLP
Los Angeles, California March 11, 2004, except for (i) the restatements as
described in Note 1 under the headings "Stock Compensation and Miscellaneous
F-3
Adjustments" and "Joint Venture Accounting and Miscellaneous Adjustments", which
appear in the consolidated financial statements included in the Company's Form
10-K/A Amendment No. 2 for the year ended December 28, 2003 and are not
presented herein, as to which the dates are May 14, 2004 and October 11, 2004,
respectively, (ii) the effect of the retroactive adoption of FIN 46 described in
Note 2 to the accompanying consolidated financial statements, as to which the
date is as of October 11, 2004, and (iii) the restatement described in Note 1
under the heading "Restatement of Financial Statements", which appears in the
consolidated financial statements included in the Company's Form 10-K for the
year ended December 26, 2004 and are not presented herein, as to which the date
is as of May 5, 2005
F-4
GRILL CONCEPTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 25, December 26,
2005 2004
------------ -------------
ASSETS
CURRENT ASSETS:
CASH AND CASH EQUIVALENTS $ 3,161,000 $ 1,407,000
INVENTORIES 727,000 620,000
RECEIVABLES, NET OF RESERVE ($238,000 AND $143,000 IN 2005 AND 2004,
RESPECTIVELY) 784,000 836,000
REIMBURSABLE COSTS RECEIVABLE 912,000 928,000
PREPAID EXPENSES AND OTHER CURRENT ASSETS 401,000 2,372,000
------------ -------------
TOTAL CURRENT ASSETS 5,985,000 6,163,000
FURNITURE, EQUIPMENT AND IMPROVEMENTS, NET 13,372,000 11,864,000
GOODWILL, NET 205,000 205,000
RESTRICTED CASH 1,042,000 882,000
NOTE RECEIVABLE 90,000 101,000
DEFERRED TAX ASSET 577,000 -
LIQUOR LICENSES 426,000 350,000
OTHER ASSETS 276,000 184,000
------------ -------------
TOTAL ASSETS $ 21,973,000 $ 19,749,000
============ =============
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
ACCOUNTS PAYABLE $ 1,457,000 $ 1,988,000
ACCRUED EXPENSES 4,533,000 2,548,000
ACCRUED MANAGED OUTLET OPERATING EXPENSES 912,000 928,000
CURRENT PORTION OF LONG-TERM DEBT 48,000 196,000
CURRENT PORTION NOTES PAYABLE - RELATED PARTIES 312,000 294,000
------------ -------------
TOTAL CURRENT LIABILITIES 7,262,000 5,954,000
LONG-TERM DEBT 206,000 148,000
NOTES PAYABLE - RELATED PARTIES 671,000 829,000
OTHER LONG-TERM LIABILITIES 7,398,000 8,054,000
------------ -------------
TOTAL LIABILITIES 15,537,000 14,985,000
------------ -------------
MINORITY INTEREST 1,630,000 934,000
COMMITMENTS AND CONTINGENCIES (NOTE 9)
STOCKHOLDERS' EQUITY:
PREFERRED STOCK, 1,000,000 SHARES AUTHORIZED, 996,935 SHARES UNDESIGNATED IN
2005 AND 2004 - -
SERIES II, 10% CONVERTIBLE PREFERRED STOCK, $.001 PAR VALUE; 500 SHARES
AUTHORIZED, 500 SHARES ISSUED AND OUTSTANDING IN 2005 AND 2004, LIQUIDATION
PREFERENCE OF $926,000 AND $876,000 IN
COMMON STOCK, $.00004 PAR VALUE; 12,000,000 SHARES AUTHORIZED IN 2005 AND
2004, 5,728,495 ISSUED AND OUTSTANDING
ADDITIONAL PAID-IN CAPITAL 13,686,000 13,649,000
ACCUMULATED DEFICIT (8,880,000) (9,819,000)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 4,806,000 3,830,000
------------ ------------
TOTAL LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY $ 21,973,000 $ 19,749,000
============ ============
F-5
GRILL CONCEPTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
DECEMBER 25, DECEMBER 26, DECEMBER 28,
2005 2004 2003
----------- ----------- -----------
REVENUES:
SALES $54,706,000 $49,938,000 $45,858,000
COST REIMBURSEMENTS 14,299,000 12,439,000 9,728,000
MANAGEMENT AND LICENSE FEES 1,683,000 1,282,000 1,037,000
----------- ----------- -----------
TOTAL REVENUES 70,688,000 63,659,000 56,623,000
OPERATING EXPENSES:
COST OF SALES (EXCLUSIVE OF DEPRECIATION, PRESENTED
SEPARATELY BELOW) 15,446,000 14,465,000 13,274,000
RESTAURANT OPERATING EXPENSES 32,844,000 30,552,000 28,050,000
REIMBURSED COSTS 14,299,000 12,439,000 9,772,000
GENERAL AND ADMINISTRATIVE 4,868,000 4,472,000 3,696,000
DEPRECIATION AND AMORTIZATION 2,248,000 2,005,000 1,816,000
PRE-OPENING COSTS 301,000 167,000 182,000
GAIN ON SALE OF ASSETS (5,000) (2,000) (11,000)
----------- ----------- -----------
TOTAL OPERATING EXPENSES 70,001,000 64,098,000 56,779,000
----------- ----------- -----------
INCOME (LOSS) FROM OPERATIONS 687,000 (439,000) (156,000)
INTEREST EXPENSE, NET (3,000) (98,000) (138,000)
INTEREST EXPENSE - RELATED PARTIES (125,000) (174,000) (193,000)
----------- ----------- -----------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES AND
MINORITY INTEREST 559,000 (711,000) (487,000)
PROVISION FOR INCOME TAXES (179,000) (65,000) (89,000)
----------- ----------- -----------
INCOME (LOSS) BEFORE MINORITY INTEREST 380,000 (776,000) (576,000)
MINORITY INTEREST IN NET LOSS OF SUBSIDIARIES 559,000 814,000 704,000
----------- ----------- -----------
NET INCOME 939,000 38,000 128,000
PREFERRED DIVIDENDS ACCRUED (50,000) (50,000) (50,000)
----------- ----------- -----------
NET INCOME (LOSS) APPLICABLE TO COMMON STOCK $ 889,000 $ (12,000) $ 78,000
=========== =========== ===========
NET INCOME PER SHARE APPLICABLE TO COMMON STOCK:
BASIC NET INCOME $ 0.16 $ - $ 0.01
=========== =========== ===========
DILUTED NET INCOME $ 0.14 $ - $ 0.01
=========== =========== ===========
AVERAGE-WEIGHTED SHARES OUTSTANDING:
BASIC 5,691,523 5,608,541 5,537,071
=========== =========== ============
DILUTED 6,251,042 5,608,541 5,640,842
=========== =========== ============
F-6
GRILL CONCEPTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
SERIES II PREFERRED STOCK COMMON STOCK ADDITIONAL
PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
----------- --------- --------- --------- ----------- ------------ -------
BALANCE, DECEMBER 29, 2002 500 $ - 5,537,071 $ - $13,601,000 $ (9,985,000) $3,616,000
NET INCOME - - - - - 128,000 128,000
----------- --------- --------- --------- ----------- ----------- ----------
BALANCE, DECEMBER 28, 2003 500 - 5,537,071 - 13,601,000 (9,857,000) 3,744,000
EXERCISE OF STOCK OPTIONS AND WARRANTS 113,075 48,000 48,000
NET INCOME - - - - - 38,000 38,000
----------- --------- --------- --------- ------------ ----------- ----------
BALANCE, DECEMBER 26, 2004 500 - 5,650,146 - 13,649,000 (9,819,000) 3,830,000
----------- --------- --------- --------- ------------ ----------- ----------
EXERCISE OF STOCK OPTIONS AND WARRANTS - - 78,349 - 37,000 - 37,000
NET INCOME - - - - - 939,000 939,000
- ----------- --------- --------- --------- ------------ ------------ ----------
BALANCE, DECEMBER 25, 2005 500 $ - 5,728,495 $ - $ 13,686,000 $ (8,880,000) $4,806,000
=========== ========= ========= ========= ============= ============ ==========
F-7
GRILL CONCEPTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
DECEMBER 28, DECEMBER 25, DECEMBER 26,
2005 2004 2003
------------- ----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $ 939,000 $ 38,000 $ 128,000
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES:
DEPRECIATION AND AMORTIZATION 2,248,000 2,005,000 1,816,000
STOCK BASED COMPENSATION EXPENSE (INCOME) - (84,000) 168,000
PROVISION FOR DOUBTFUL ACCOUNTS 95,000 130,000 (33,000)
AMORTIZED DEFERRED RENT AND LEASE INCENTIVES (656,000) (342,000) (72,000)
DEFERRED INCOME TAXES (577,000) -
GAIN ON SALE OF ASSETS (5,000) (2,000) (11,000)
MINORITY INTEREST IN NET LOSS OF SUBSIDIARIES (559,000) (814,000) (704,000)
CHANGES IN OPERATING ASSETS AND LIABILITIES:
INVENTORIES (107,000) (35,000) (103,000)
RECEIVABLES (43,000) (308,000) (142,000)
REIMBURSABLE COSTS RECEIVABLE 16,000 (348,000) (82,000)
PREPAID EXPENSES AND OTHER CURRENT ASSETS 120,000 91,000 (983,000)
TENANT IMPROVEMENT ALLOWANCES 1,851,000 2,065,000 1,800,000
OTHER ASSETS (117,000) 73,000 34,000
ACCOUNTS PAYABLE (531,000) 942,000 28,000
ACCRUED EXPENSES 1,909,000 374,000 (81,000)
REIMBURSABLE COSTS PAYABLE (16,000) 348,000 82,000
------------- ----------- ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 4,567,000 4,133,000 1,845,000
------------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
CHANGE IN RESTRICTED CASH (160,000) (810,000) 544,000
PROCEEDS FROM DISPOSAL OF FIXED ASSETS 5,000 5,000 26,000
REPAYMENTS FROM MANAGED OUTLETS - - 64,000
PURCHASE OF LIQUOR LICENSES (76,000) - (12,000)
PURCHASE OF FURNITURE, EQUIPMENT AND IMPROVEMENTS (3,731,000) (2,866,000) (1,389,000)
------------- ----------- ------------
NET CASH USED IN INVESTING ACTIVITIES (3,962,000) (3,671,000) (767,000)
------------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
CAPITAL CONTRIBUTIONS FROM MINORITY INTEREST MEMBERS IN LLCS 1,555,000 35,000 50,000
RETURN OF CAPITAL, PREFERRED RETURN AND PROFIT TO MINORITY MEMBER (228,000) (171,000) (275,000)
PROCEEDS FROM EQUIPMENT FINANCING 118,000 45,000 -
COLLECTIONS OF NOTE RECEIVABLE 15,000 15,000 15,000
PAYMENTS ON LONG TERM DEBT (208,000) (284,000) (445,000)
PAYMENTS ON NOTES PAYABLE - RELATED PARTIES (140,000) (191,000) (217,000)
Proceeds on exercise of stock options 37,000
------------- ----------- ------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 1,149,000 (551,000) (872,000)
------------- ----------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 1,754,000 (89,000) 206,000
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,407,000 1,496,000 1,290,000
------------- ----------- ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 3,161,000 $ 1,407,000 $ 1,496,000
============= =========== ============
SUPPLEMENTAL CASH FLOWS INFORMATION:
CASH PAID DURING THE YEAR FOR:
INTEREST $ 178,000 $ 141,000 $ 260,000
INCOME TAXES $ 384,000 $ 181,000 $ 175,000
F-8
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS, ORGANIZATION AND BASIS OF PRESENTATION
GENERAL
Grill Concepts, Inc. (the "Company") is incorporated under the laws of the
State of Delaware. The Company operates exclusively in the restaurant
industry in the United States. At December 25, 2005, the Company owned and
operated sixteen restaurants, consisting of nine Daily Grill restaurants in
California; The Grill on the Alley ("The Grill"); The Grill in San Jose
("The San Jose Grill LLC"); The Grill in Chicago ("Chicago - The Grill on
the Alley LLC"); The Grill on Hollywood ("The Grill on Hollywood, LLC"):
one Daily Grill in Washington, D.C.; one Daily Grill in Virginia; and one
Daily Grill in Maryland. Each of the Company's restaurants is owned and
operated on a non-franchise basis by the Company. In addition the Company
manages six Daily Grill restaurants and licenses two additional Daily Grill
restaurants. During 2004 the San Jose City Bar and Grill terminated their
license agreement.
LIQUIDITY
At December 25, 2005, the Company had a working capital deficit of $1.3
million and a cash balance of $3.2 million as compared to a working capital
surplus of $0.2 million and a cash balance of $1.4 million at December 26,
2004. The increase in the Company's cash was primarily attributable to cash
provided by operations $4.6 million including tenant improvement allowances
of $1.9 million and $1.6 million of capital contributions from minority
interest members in the LLCs, partially offset by purchases of fixed assets
of $3.7 million, increases in restricted cash $0.2 million and repayment of
debt of $0.3 million.
The Company's need for capital resources historically has resulted from,
and for the foreseeable future is expected to relate primarily to, the
construction and opening of new restaurants. Historically, the Company has
funded its day-to-day operations through its operating cash flows which
have ranged from $1.8 million to $4.6 million over the past three fiscal
years. Growth has been funded through a combination of bank borrowings,
loans from stockholders/officers, the sale of debentures and stock, loans
and tenant allowances from certain of its landlords, and, beginning in
1999, through joint venture arrangements. Capital expenditures were $1.4
million in 2003, $2.9 million in 2004 and $3.7 million in 2005.
At December 25, 2005, the Company has a bank credit facility which will
expire August 4, 2006. The terms of the bank credit facility provide for
financing in the form of a revolving line of credit in the amount of
$500,000, an irrevocable standby letter of credit in the amount of
$860,000, increased to $1,010,000 in January 2006, and equipment financing
in the amount of $500,000. In November 2005 the Company amended the
equipment financing portion of the facility increasing the amount to
$600,000 for equipment to be delivered on or before June 30, 2006, with
F-9
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS, ORGANIZATION AND BASIS OF PRESENTATION (CONTINUED)
payments to be for terms of three to five years with interest at the bank's
reference rate. The facility is secured by assets and is subject to certain
standard borrowing covenants. The Company has not utilized any funds from
the current or prior lines of credit dating back to 2001 and only utilized
$158,000 of the equipment financing. Interest is at the bank's variable
reference rate.
At December 25, 2005, the Company had $143,000 owing under the above
mentioned equipment financing, an obligation to a member of Chicago - The
Grill on the Alley, LLC of $0.8 million for a guaranteed return of its
invested capital, loans from stockholders/ officers/directors of $0.2
million, and loans/advances from a landlord of $0.1 million.
The Company projects increased operating cash flows in 2006 which, when
added to existing cash balances, will allow it to meet all operating,
investing and financing needs. Such projections are based on sales
increases due to store openings, as well as modest increases in same store
sales. Management believes it can respond to a decrease in sales through
cost controls, reductions in discretionary capital improvements and
borrowings under the credit facility. Management believes that the Company
has adequate resources on hand and operating cash flows to sustain
operations for at least the following 12 months through December 2006.
In March 2006 the Company signed a new financing agreement for a $8
million line of credit at which time the previous line of credit was
terminated. (see Note 12 Subsequent Events)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION AND MINORITY INTEREST
The consolidated financial statements for the period ended December 25,
2005 include the accounts of Grill Concepts, Inc. and its wholly-owned
subsidiaries, which include The Grill on the Alley, Universal Grill
Concepts, Inc., Grill Concepts Management, Inc., Grill Concepts CD, Inc.,
six majority-owned subsidiaries: The San Jose Grill LLC, Chicago - The
Grill on the Alley, LLC, The Grill on Hollywood, LLC, the Daily Grill at
Continental Park, LLC, and 612 Flower Daily Grill, LLC and Universal Grill
Concepts Inc.'s investment in the Universal CityWalk Daily Grill. All
significant inter-company accounts and transactions for the periods
presented have been eliminated in consolidation. The allocated interest of
the earnings or loss of majority-owned subsidiaries attributable to the
minority owners of those subsidiaries is reflected in a single statement of
operations line, with minority interests in earnings being a reduction in
net income and minority interests in losses being an increase in net
income. The proportionate interest in the equity of majority-owned
subsidiaries attributable to the minority owners of those subsidiaries is
reflected as a single balance sheet line between liabilities and
stockholders' equity.
The Company allocates profits and losses to the minority interest in its
partially owned subsidiaries based on the underlying economics of the
investment. These may or may not reflect the Company's ownership percentage
and can be inconsistent with the allocation provisions specified in the
joint venture agreements. Where there is a disparity among the ownership
percentages, the terms of the agreements and the underlying economics, the
Company utilizes a hypothetical liquidation model to allocate profits and
losses. Under this model, all of the venture's assets and liabilities as
reflected in the balance sheet are assumed to be realized at their GAAP
F-10
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
carrying values. The hypothetical liquidating proceeds are calculated at
the end of each period and applied to the capital accounts as would occur
under a true liquidation scenario. The change in this balance from period
to period represents the investors' share of the income or loss.
We reported a minority interest in the loss of our majority owned
subsidiaries of $559,000 during 2005, consisting of a minority interest in
the earnings of San Jose Grill on the Alley, LLC of $162,000, a minority
interest in the loss of The Grill on Hollywood, LLC of $109,000, a minority
interest in the loss of The Daily Grill at Continental Park, LLC of
$194,000, a minority interest in the loss of the 612 Flower Daily Grill LLC
of $138,000 and a partnership loss in the Universal CityWalk Daily Grill of
$280,000. During 2004 we reported a minority interest in the loss of our
majority owned subsidiaries of $814,000, consisting of a minority interest
in the earnings of San Jose Grill on the Alley, LLC of $154,000, a minority
interest in the loss of The Grill on Hollywood, LLC of $357,000 and a
minority interest allocation from The Daily Grill at Continental Park of
$483,000, a minority interest in the loss of the 612 Flower Daily Grill LLC
of $3,000 and partnership loss in the Universal CityWalk Daily Grill of
$125,000.
Effective December 28, 2003, the Company retroactively adopted the
provisions of FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51" and restated the prior
period financial statements. Under FIN 46, an entity is considered to be a
variable interest entity ("VIE") when it has equity investors which lack
the characteristics of a controlling financial interest, or its capital is
insufficient to permit it to finance its activities without additional
subordinated financial support. Consolidation of a VIE by an investor is
required when it is determined that the investor is the primary beneficiary
and will absorb a majority of the VIE's expected losses or residual returns
if they occur.
Management has assessed all entities which are not wholly owned by the
Company to determine if these entities would be considered VIEs and whether
the Company would be considered the primary beneficiary. It was determined
that all of the following entities would be considered VIEs: The San Jose
Grill LLC, Chicago - The Grill on the Alley LLC, The Grill on Hollywood
LLC, The Daily Grill at Continental Park LLC, 612 Flower Daily Grill and
the Universal CityWalk Daily Grill joint partnership. The Company has
determined it is the primary beneficiary for all these entities.
In connection with the building of a new restaurant, in June 2004, the 612
Flower Daily Grill, LLC was formed for the operation of the Daily Grill in
downtown Los Angeles of which the Company owns 58.4%. Construction of the
restaurant was funded primarily by a capital contribution of $1,375,000
from the minority interest member of the limited liability company and a
tenant improvement allowance of $600,000 from the landlord. The Company has
contributed $375,000 as its investment in the LLC. The restaurant opened
May 31, 2005. The 612 Flower Daily Grill, LLC is considered a variable
interest entity for which the Company is the primary beneficiary and
consolidated financial statements include the accounts of the limited
liability company with minority interest reflected according to provisions
of the LLC agreement. The Company guaranteed the lease. Total assets and
restaurant sales of the 612 Flower Daily Grill, LLC as of and for the year
ended December 25, 2005 were approximately $2.4 million and $2.1 million,
respectively.
F-11
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In connection with the building of a new restaurant, in May 2002, The Daily
Grill at Continental Park, LLC was formed for the operation of the Daily
Grill at Continental Park in El Segundo, California of which the Company
owns 50.1%. Construction of the restaurant has been funded primarily by a
capital contribution of $1,000,000 from the minority interest member of the
limited liability company and a tenant improvement allowance of $500,000
received from the landlord. The Company contributed $350,000 in July 2002
as its investment in the limited liability company. The restaurant opened
January 16, 2003. The Daily Grill at Continental Park, LLC is considered a
variable interest entity for which the Company is the primary beneficiary.
Since adoption of FIN 46, the consolidated financial statements include the
accounts of the limited liability company with minority interest reflected
using the hypothetical liquidation model. Total assets and restaurant sales
of the Daily Grill at Continental Park, LLC as of and for the year ended
December 25, 2005 were approximately $1.4 million and $2.4 million,
respectively.
In connection with the building of a new restaurant, in July 2001, The
Grill on Hollywood, LLC was formed for the operation of "The Grill on
Hollywood" restaurant in Hollywood, California, of which the Company owns
51%. Construction of the restaurant was funded by a capital contribution of
$1,200,000 from the minority interest member and a tenant improvement
allowance of up to $1,015,000 received from the landlord. The Company
contributed $250,000 to the limited liability company. The LLC is
considered a variable interest entity for which the Company is the primary
beneficiary and is consolidated in the financial statements that include
the accounts of the limited liability company with minority interest
reflected using the hypothetical liquidation model. Total assets and
restaurant sales of the Grill on Hollywood as of and for the year ended
December 25, 2005 were approximately $0.8 million and $2.9 million,
respectively.
In connection with the building of a new restaurant in June 1999, the
Universal CityWalk Daily Grill joint partnership was formed for the purpose
of owning and operating the "Daily Grill Short Order" restaurant located in
the retail and entertainment district of Universal CityWalk Hollywood in
Universal City, California. The partners of the entity are Universal Grill
Concepts, Inc., a wholly owned subsidiary of the Company, which holds a
partner's percentage interest of 50%, and Universal Studios Development
Venture Six, a California corporation which holds the remaining partnership
percentage interest of 50%. The joint venture is considered a variable
interest entity for which the Company is the primary beneficiary. Upon
adoption of FIN 46, the Company consolidated the results of the joint
venture. Total assets and restaurant sales of the Universal Grill as of and
for the year ended December 25, 2005 were approximately $0.8 million and
$2.0 million, respectively.
In connection with the building of a new restaurant, in February 1999,
Chicago - The Grill on the Alley, LLC was formed for the operation of "The
Grill on the Alley" restaurant in Chicago, Illinois, of which the Company
owns 60.0%. Construction of the restaurant was funded primarily by a
capital contribution of $1,190,000 and a loan of $510,000 from the minority
interest member of the limited liability company and $750,000 of equipment
financing. Chicago - The Grill on the Alley is considered a variable
F-12
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
interest entity for which the company is the primary beneficiary. As a
result of the adoption of FIN 46, the consolidated financial statements
include the accounts of the limited liability company. Under the terms of
the joint venture agreement, the limited liability company is obligated to
repay both the capital contribution of the minority interest member and the
loan, both of which accrue interest at eight percent per annum. The Company
has guaranteed the joint venture's repayment of both the loan and the
contributed capital and therefore recorded the full amount of this
obligation as part of related party debt and not as minority interest.
Losses generated by the limited liability company have been recognized in
the Company's statement of operations with no allocation to the minority
interest member. Total assets and restaurant sales of Chicago - The Grill
on the Alley LLC as of and for the year ended December 25, 2005 were
approximately $1.6 million and $5.4 million, respectively.
In connection with the building of a new restaurant, in January 1998, The
San Jose Grill LLC was formed for the operation of "The Grill" restaurant
in San Jose, California, of which the Company owns 50.05%. Construction of
the restaurant was funded primarily by a capital contribution from the
Company of $350,350 and by a capital contribution of $349,650 and a
$800,000 loan from the minority interest member of the limited liability
company. The San Jose Grill LLC is considered a variable interest entity
for which the Company is the primary beneficiary. As a result of the
adoption of FIN 46 the consolidated financial statements include the
accounts of the limited liability company with minority interest reflected
according to the provisions of the LLC agreement. Total assets and
restaurant sales of the San Jose Grill LLC as of and for the year ended
December 25, 2005 were approximately $1.7 million and $4.9 million,
respectively.
FISCAL YEAR
The Company's fiscal year is the 52 or 53 weeks ending the last Sunday in
the calendar year. The fiscal years 2005, 2004 and 2003 consisted of 52
weeks ended December 25, 2005, December 26, 2004, and December 28, 2003,
respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company's management to make
estimates and assumptions for the reporting period and as of the financial
statement date. These estimates and assumptions affect the reported amounts
of assets and liabilities, the disclosure of contingent liabilities, and
the reported amounts of revenue and expenses. Actual results could differ
from these estimates.
REVENUE RECOGNITION
Revenue from restaurant sales is recognized when food and beverage products
are sold. Management and license fees are typically determined based on a
percentage of revenues and are recognized on an accrual basis when earned.
Reimbursements for restaurant operating expenses are recorded as revenues
F-13
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
in accordance with EITF 01-14, "Income Statement Characterization of
Reimbursements Received for 'Out-of- Pocket' Expenses Incurred," as the
Company is considered to be the primary obligor with respect to restaurant
operating expenses.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less at date of purchase to be cash
equivalents.
RESTRICTED CASH
In January 2005 a $860,000 certificate of deposit was established at Union
Bank to act as collateral for the Standby Letter of Credit opened to
support our new Workers Compensation policy. Other restricted cash consists
of $72,000 held in escrow for the Daily Grill at Continental Park in El
Segundo, California and $110,000 that was placed in escrow with our
insurance claims processor in 2004 for worker's compensation claims.
At December 26, 2004 restricted cash consisted of $700,000 certificate of
deposit serving as collateral for our Standby Letter of Credit, $72,000
held in escrow for the Daily Grill at Continental Park in El Segundo,
California and $110,000 that was placed in escrow with our insurance claims
processor in 2004 for worker's compensation claims.
WORKER'S COMPENSATION LOSS RESERVE
In the first quarter of 2004, the Company obtained a large deductible
worker's compensation policy for 2004 that includes a deductible per
occurrence of $250,000 subject to a maximum aggregate loss of $1.7 million.
The Company has established a loss reserve to cover the potential
deductible amounts. The loss reserve is determined by estimating the
ultimate cost to the Company utilizing information on current accidents,
prior year experience and the carrier's loss development and loss trend
factors. See note 4.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to a
concentration of credit risk are cash and cash equivalents. The Company
currently maintains substantially all of its day-to-day operating cash
balances with major financial institutions. At times during the year, and
at December 25, 2005, cash balances were in excess of Federal Depository
Insurance Corporation ("FDIC") insurance limits.
INVENTORIES
Inventories consist of food, soft beverages, wine and liquor and are stated
at the lower of cost or market, cost generally being determined on a
first-in, first-out basis.
F-14
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACCOUNTS RECEIVABLES
Accounts receivable consist of amounts due from our managed outlets, hotel
charges and various food delivery companies, and are recorded when the
products or services have been delivered.
The Company reviews the collectability of its receivables on an ongoing
basis, and provides for an allowance when it considers the entity unable to
meet its obligation. Due to the continued lower than expected performance
at the Portland Daily Grill restaurant which was opened in September 2003,
we have not received any of the management fees earned at this location and
therefore, a full reserve was established for these receivables in 2005 and
2004.
Allowance for doubtful accounts is as follows:
Balance at Additions Net Balance
Beginning Charged to Deductions At End
Of Year Operations Of Year
Allowance for
Doubtful Accounts
Year Ended
December 28, 2003 $ 46,000 $ 29,000 $ 62,000 $ 13,000
December 26, 2004 $ 13,000 $134,000 $ 4,000 $143,000
December 25, 2005 $143,000 $ 95,000 - $238,000
PREPAID EXPENSES AND OTHER CURRENT ASSETS
Most lease agreements contain one or more of the following; tenant
improvement allowances, rent holidays, rent escalation clauses and/or
contingent rent provisions.
Rent is recognized on a straight-line basis, including over the restaurant
build-out period. This period is normally prior to the commencement of rent
payments and is commonly called the rent holiday period. The build-out
period generally begins when the Company enters the space and begins to
make improvements in preparation for intended use. Tenant improvement
allowances are also recognized on a straight-line basis over the lease
term.
Prepaid expenses and other current assets at December 25, 2005 and December
26, 2004 were comprised of:
2005 2004
----------- -----------
Tenant Improvement Allowances
receivable $ - $ 1,851,000
Prepaid expenses, other 401,000 521,000
----------- -----------
Total prepaid assets and other
current assets $ 401,000 $ 2,372,000
=========== ===========
F-15
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FURNITURE, EQUIPMENT AND IMPROVEMENTS
Furniture, equipment and improvements are stated at cost.
Depreciation of furniture and equipment is computed by use of the
straight-line method based on the estimated useful lives of 3 to 10 years
of the respective assets. Leasehold improvements are amortized using the
straight-line method over the life of the improvement or the remaining life
of the lease, whichever is shorter. Interest costs incurred during
construction were capitalized and are being amortized over the related
assets' estimated useful lives. When properties are retired or otherwise
disposed of, the costs and related accumulated depreciation are removed
from the accounts, and the resulting gain or loss is credited or charged to
current-year operations. The policy of the Company is to charge amounts
expended for maintenance and repairs to current-year expense and to
capitalize expenditures for major replacements and betterments.
GOODWILL
Goodwill relates to the excess of cost over the fair value of the net
assets of The Grill on the Alley in Beverly Hills, California acquired in
April 1996. The Company accounts for goodwill under the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangibles." SFAS No. 142 addresses financial accounting and
reporting requirements for acquired goodwill and other intangible assets.
In accordance with SFAS No. 142, goodwill is deemed to have an indefinite
useful life and is not amortized but rather, tested at least annually for
impairment. An impairment loss should be recognized if the carrying amount
of goodwill is not recoverable and the carrying amount exceeds its fair
value. The Company has not recognized any impairment losses.
EXPENDABLES
Initial amounts spent for china, glassware and flatware in connection with
the opening of a new restaurant are capitalized and not amortized.
Subsequent purchases are expensed as incurred.
LIQUOR LICENSES
The cost of acquiring liquor licenses is capitalized at cost and is stated
at the lower of cost or market. Such costs are not amortized as the
licenses have an indefinite life.
F-16
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OTHER LONG TERM LIABILITIES
In connection with certain of the Company's leases, the landlord has
provided the Company with tenant improvement allowances. These lease
incentives have been recorded as long-term liabilities and are being
amortized over the life of the lease. Additionally, the Company recognizes
a liability for deferred rent where lease payments are lower than rental
expense recognized on a straight-line basis.
Other Long-Term Liabilities at December 25, 2005 and December 26, 2004 were
comprised of:
2005 2004
------------ ------------
Tenant Improvement Allowances $ 5,140,000 $ 5,653,000
Deferred Rent 2,258,000 2,401,000
------------ ------------
Total Other Long-Term Liabilities $ 7,398,000 $ 8,054,000
============ ============
PRE-OPENING COSTS
Pre-opening costs are expensed as incurred.
INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," which prescribes an asset and liability
approach. Under the asset and liability method, deferred income taxes are
recognized for the tax consequences of "temporary differences" by applying
enacted statutory rates applicable to future years to the difference
between the financial statement carrying amounts and the tax basis of
existing assets and liabilities. The effect on deferred taxes of a change
in tax rates is recognized in income in the period that includes the
enactment date. The Company establishes a valuation allowance to reduce net
deferred tax assets to the amount expected to be realized.
ADVERTISING AND PROMOTION COSTS
All costs associated with advertising and promoting products are expensed
as incurred. Advertising and promotion expense for the years ended December
25, 2005, December 26, 2004 and December 28, 2003 was $565,000, $571,000,
and $296,000, respectively.
REIMBURSED COSTS
Expenses related to non-consolidated restaurants operated under management
agreements for which the Company is considered the primary obligor are
recorded in the statement of operations. Reimbursements for such expenses
are recorded as revenues.
F-17
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LONG-LIVED ASSETS
Long-lived assets held and used by the Company are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. For purposes of evaluating the
recoverability of long-lived assets, the recoverability test is performed
using undiscounted future cash flows of the individual restaurants and
consolidated undiscounted future cash flows for long-lived assets not
identifiable to individual restaurants compared to the related carrying
value. If the undiscounted future cash flow is less than the carrying
value, the amount of the impairment, if any, is determined by comparing the
carrying value of each asset with its fair value. Fair value is generally
based on a discounted cash flow analysis. Based on its review, the Company
does not believe that any impairment of its long-lived assets has occurred.
STOCK-BASED COMPENSATION
In December 2002, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure," which amends SFAS No. 123. SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value based method
of accounting for stock-based compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect
of the method used on reported results of operations. As the Company has
not elected to change to the fair value based method of accounting for
stock based employee compensation, the adoption of SFAS No. 148 did not
have a material impact on the Company's financial position or results of
operations. All disclosure requirements of SFAS No. 148 have been adopted
and are reflected in these financial statements.
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees," and related
interpretations, and complies with the disclosure provisions of SFAS No.
123, "Accounting for Stock-Based Compensation." Under APB 25, compensation
expense is based on the difference, if any, on the date of grant between
the fair value of the Company's stock and the amount an employee must pay
to acquire the stock. Because grants under the plan require variable
accounting treatment due to the cashless exercise feature of those options
(described below), compensation expense is remeasured at each balance sheet
date based on the difference between the current market price of the
Company's stock and the option exercise price. An accrual for compensation
F-18
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
expense is determined based on the proportionate vested amountof each
option as prescribed by Financial Interpretation No. 28, "Accounting for
Stock Appreciation Rights and Other Variable Stock Option or Award Plans."
Each period, adjustments to the accrual are recognized in the income
statement. The Company accounts for stock and options to non-employees at
fair value in accordance with the provisions of SFAS No. 123 and the
Emerging Issues Task Force Consensus on Issue No. 96-18.
On June 1, 1995, the Company's Board of Directors adopted the Grill
Concepts, Inc. 1995 Stock Option Plan (the "1995 Plan") and on June 12,
1998 the 1998 Stock Option Plan (the "1998 Plan") was adopted. These Plans
provide for options to be issued to the Company's employees and others. The
exercise price of the shares under option shall be equal to or exceed 100%
of the fair market value of the shares at the date of grant. The options
generally vest over a five-year period. The terms of the option grants
originally allowed the employee to exercise the option by surrendering a
portion of the vested shares in lieu of paying cash, subject to the terms
of the plan including the rights of the Compensation Committee to amend
grants in any manner that the committee in its sole discretion deems to not
adversely impact the option holders.
On June 23, 2004, the Company's Compensation Committee, as administrators
of the Company's stock option plans, resolved that the cashless exercise
feature in the Company's stock option plan will not be permitted, and a
notification was subsequently given to all employees on July 30, 2004.
Effective with this date, the Company reverted back to accounting for its
options under the fixed accounting treatment.
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," and will continue to use the
intrinsic value-based method of accounting prescribed by APB Opinion No.
25, "Accounting for Stock Issued to Employees." Pro forma compensation
expense for the Company's stock option plans determined based on the fair
value at the grant date for awards in fiscal year 2005, 2004 and 2003 would
have been as follows:
2005 2004 2003
---- ---- ----
Net income, as reported $ 939,000 $ 38,000 $ 128,000
Add: Stock compensation expense
recorded, net of taxes - 84,000 168,000
Deduct: Stock compensation
expense under fair value method,
net of taxes (151,000) (189,000) (163,000)
--------- -------- ---------
Net income (loss), pro forma $ 788,000 $(67,000) $133,000
Net income per share, ========= ======== ========
as reported:
Basic $ 0.16 $ 0.00 $ 0.01
Diluted $ 0.14 $ 0.00 $ 0.01
Net income (loss) per share, pro forma:
Basic $ 0.13 $ (0.02) $ 0.01
Diluted $ 0.13 $ (0.02) $ 0.01
F-19
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The fair value of each option grant issued in fiscal year 2005, 2004 and
2003 is estimated at the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions: (a)
no dividend yield on the Company's stock, (b) expected volatility ranging
from 68.59% to 71.35%, (c) risk-free interest rates ranging from 2.5% to
4.87%, and (d) expected option lives of five and ten years.
The weighted average fair value of options granted at market price during
2005, 2004 and 2003 was $2.79, $1.85, and $1.39, respectively.
NET INCOME PER SHARE
Pursuant to SFAS No. 128, "Earnings Per Share," basic net income per share
is computed by dividing the net income attributable to common shareholders
by the weighted-average number of common shares outstanding during the
period. Diluted net income per share is computed by dividing the net income
attributable to common shareholders by the weighted-average number of
common and common equivalent shares outstanding during the period. Common
share equivalents included in the diluted computation represent shares
issuable upon assumed exercise of stock options, warrants and convertible
preferred stocks using the treasury stock method.
A reconciliation of earnings available to common stockholders and diluted
earnings available to common stockholders and the related weighted average
shares for the years ended December 25, 2005, December 26, 2004 and
December 28, 2003 follows:
2005 2004 2003
---------------------------------------------------------------------------
Earnings Shares Earnings Shares Earnings Shares
---------- --------- -------- -------- -------- -------
Net income $ 939,000 $ 38,000 $128,000
Less: preferred
dividends accrued (50,000) (50,000) (50,000)
---------- -------- --------
Net income (loss)
applicable to common
stock 889,000 5,691,523 (12,000) 5,608,541 78,000 5,537,071
Dilutive securities:
Dilutive stock options 125,035 - 47,565
Warrants - 434,484 - - - 56,206
---------- --------- -------- --------- -------- ---------
Diluted earnings (loss)
available to common
stockholders $889,000 6,251,042 $(12,000) 5,608,541 $ 78,000 5,640,842
========== ========= ======== ========= ======== =========
Stock options exercisable into 334,375, 678,425, and 454,475 shares, for
2005, 2004 and 2003, respectively, were excluded from the calculation of
diluted earnings per share because they were anti-dilutive. Warrants
exercisable into 26,562, 1,719,037, and 1,722,786 shares for 2005.
F-20
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
2004 and 2003, respectively, were excluded from the calculation of diluted
earnings per share because they were anti-dilutive.
DISTRIBUTION OF CAPITAL AND PREFERRED RETURNS
The Company's San Jose Grill, Chicago - Grill on the Alley, Grill on
Hollywood, South Bay Daily Grill and Downtown Daily Grill restaurants are
each owned by limited liability companies (the "LLCs") for which the
Company serves as manager and owns a controlling interest. Each of the LLCs
has minority interest owners, some of whom have participating rights in the
joint venture such as the ability to approve operating and capital budgets
and the borrowing of money. In connection with the financing of each of the
LLCs, the minority members may have certain rights to priority
distributions of capital until they have received a return of their initial
investments ("Return of Member Capital") as well as rights to receive
defined preferred returns on their invested capital ("Preferred Return").
The Universal CityWalk Daily Grill is owned by a partnership ("the CityWalk
Partnership") for which we serve as manager. Our partner has certain rights
to priority distribution of capital from the CityWalk Partnership until
they have received their initial investments ("Return of Member Capital").
The principal distribution provisions with respect to each of the
restaurant LLCs and Partnership are described below. In each instance, the
balance of distributable cash represents cash available for distribution to
the members after all obligations, including minimum working capital
advances, have been satisfied. The distribution provisions outlined below
are consistent with the order of distributions in a liquidation scenario
and are utilized for purposes of allocated profits and losses under the
liquidation model described elsewhere in this report.
SAN JOSE GRILL. Distributions from the San Jose Grill are allocated as
follows: (1) until the return of the initial capital contributions and any
additional capital contributions and preferred returns, (a) 10% to the
Company, as manager, and (b) 50.05% of 90% to the Company and 49.95% of 90%
to the investor members, and (2) thereafter, (a) 16.67% to the Company, as
manager, and (b) 50.05% of 83.33% to the Company and 49.95% to the investor
members.
CHICAGO - THE GRILL ON THE ALLEY. Distributions from Chicago - The Grill on
the Alley are allocated as follows: (1) until return of the capital
contributions and preferred return, 100% to the investor members, and (2)
thereafter, 40% to the Company and 60% to the investor members.
GRILL ON HOLLYWOOD. Distributions from Grill on Hollywood are allocated as
follows: (1) until the return of the investor member's initial capital
contributions, 10% to the Company, as manager, and 90% to the investor
members, (2) thereafter and until the return of the Company's initial
capital contributions, 90% to the Company and 10% to the investor members,
(3) thereafter and until return of the preferred returns, 10% to the
Company and 90% to the investor members, and (4) thereafter, 51% to the
Company and 49% to the investor members.
F-21
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SOUTH BAY DAILY GRILL. Distributions from South Bay Daily Grill are
allocated as follows: (1) until payment in full of all deferred management
fees, 100% to the Company, as manager, (2) thereafter, until return of any
additional capital contributions, ratably between the Company and the
investor members based on total additional capital contributions, (3)
thereafter, until $300,000 of distributions are paid, 33.3% to the Company
and 66.67% to the investor members, (4) thereafter, until return of
investor member's preferred return, 10% to the Company and 90% to the
investor members, (5) thereafter, until the return of all investor member's
capital contributions, 10% to the Company and 90% to the investor members,
(6) thereafter, until return of the Company's preferred return, 90% to the
Company and 10% to the investor members, (7) thereafter, until return of
all of the Company's capital contributions, 90% to the Company and 10% to
the investor members, and (8) thereafter, 50.1% to the Company and 49.9% to
the investor members.
UNIVERSAL CITYWALK DAILY GRILL. Distributions from Universal CityWalk Daily
Grill are allocated as follows: (1) until return of additional capital
contributions 50% to the Company and 50% to the partner, (2) the next
$550,000 to the partner, (3) then until unpaid preferred return is paid in
full 100% to the partner, (4) then 80% to the partner and 20% to the
Company until return of initial capital contribution and (5) thereafter,
50% to the Company and 50% to the partner.
DOWNTOWN DAILY GRILL. Distributions from Downtown Daily Grill are allocated
as follows: (1) until return of all initial capital contributions, (a) 10%
to the Company, as manager, and (b) 15.03% to the Company, as a member, and
74.97% to the investor members, (2) thereafter, until the return of all
additional capital contributions, ratably among the Company and the
investor members based on their additional capital contributions, (3)
thereafter, until repayment of long term working capital loans by the
Company, 100% to the Company, and (4) thereafter, (a) 8.335% to the
Company, as manager, and (b) 50% to the Company, as a member, and 41.665%
to the investor members.
The following tables set forth a summary for each of the LLCs and the
CityWalk Partnership of (1) the initial capital contributions of the
Company and the minority LLC members or partner (the "Members"), (2)
additional capital contributions, (3) the distributions of capital to the
Members and/or the Company during the year ended December 25, 2005, (4) the
unreturned balance of the capital contributions of the Members and/or the
Company at December 25, 2005, (5) the Preferred Return rate to Members
and/or the Company, (6) the accrued but unpaid preferred returns due to the
Members and/or the Company at December 25, 2005, and (7) the management
incentive fees, if any, payable to the Company.
F-22
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SAN JOSE CHICAGO GRILL ON THE ALLEY THE GRILL ON HOLLYWOOD LLC
-------- --------------------------
Members Company Members Company Members Company
Initial Capital
Contribution: $1,149,650 $350,350 $1,700,000(b) $- $1,200,000 $250,000
=========================================================================================
Distributions of profit
and note repayments
during the year ended
December 25,2005: $228,000 $228,000 $252,000 $- - -
=========================================================================================
Unreturned Initial Capital
Contributions at
December 25, 2005: $- $- $904,000 $- $1,200,000 $250,000
=========================================================================================
Preferred Return rate: 10% 10% 8% 12% 12%
=========================================================================================
Accrued but unpaid
Preferred Returns at
December 25, 2005: $- $- $- (d) (d)
=========================================================================================
Management Fee: 5% 5% 5%
=========================================================================================
SOUTH BAY DAILY GRILL UNIVERSAL CITYWALK DAILY 612 Flower Daily Grill LLC
--------------------- --------------------------
(CONTINENTAL PARK LLC) GRILL DOWNTOWN
---------------------- --------------------------
Members Company Members Company Members Company
(e)
Initial Capital
Contribution: $ 1,000,000 $ 350,000 $ 1,100,000 - $ 1,375,000 $ 275,000
=========================================================================================
Additional capital
contributions - $ 100,000 $ 296,106 $ 296,106 - -
=========================================================================================
Distributions of profit
during the year
ended December 25, 2005: - - - - - -
=========================================================================================
Unreturned Initial and
Additional Capital
Contributions at
December 25, 2005: $ 1,000,000 $ 350,000 $ 1,396,106 $ 296,106 $ 1,375,000 $ 275,000
=========================================================================================
Preferred Return
rate: 10% 10% (C) - - 9% 9%
=========================================================================================
Accrued but unpaid
Preferred Returns at
December 25, 2005: (d) (d) (d) - $ 72,254 $ 18,584
=========================================================================================
Management Fee: 5% 5% 5%
=========================================================================================
F-23
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(a) The initial capital contributions of the Members of San Jose
Grill LLC consisted of a capital contribution of $349,650 and a loan
of $800,000.
(b) The initial capital contributions of the Members of Chicago -
Grill on the Alley LLC consisted of a capital contribution of $1,000
and a loan of $1,699,000. $1,189,000 of the loan was converted to
capital in 1999. Under the terms of the joint venture agreement, the
LLC is obligated to repay both the converted capital and loan and the
Company guaranteed the joint venture's payment of these obligations.
Distributions of capital and note repayments for the year ended
December 25, 2005 includes $172,000 of capital and note payments and
$80,000 of interest and preferred return. No losses are allocated to
the minority interest partner as the investor has no equity at risk.
The loan of $1,699,000 is reflected on the balance sheet as notes
payable - related parties.
(c) The Company's preferred return with respect to the South Bay
Daily Grill is based on unrecovered capital contribution and accrued
but unpaid management fees.
(d) Due to the poor performance of the restaurant the preferred
return is not being accrued. The Company is not liable to pay the
preferred return distributions, such that they represent a
non-recourse obligation to the subsidiary entity. If preferred returns
were accrued for The Grill on Hollywood the member would have an
accrued preferred return of $766,000 and the Company would have an
accrued preferred return of $160,000. If preferred returns were
accrued for the South Bay Daily Grill the member would have an accrued
preferred return of $353,000 and the Company would have an accrued
preferred return of $137,000. If preferred returns were accrued for
the CityWalk Partnership the member would have an accrued preferred
return of $528,000.
(e) The Company is a non-managing member and a wholly owned
subsidiary of the Company is the Manager of this restaurant.
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosure About Fair Value of Financial Instruments,"
requires disclosure of fair value information about most financial
instruments both on and off the balance sheet, if it is practicable to
estimate. SFAS No. 107 excludes certain financial instruments, such as
certain insurance contracts, and all non-financial instruments from its
disclosure requirements. Disclosures regarding the fair value of financial
instruments have been derived using external market sources, estimates
using present value or other valuation techniques.
The Company's management believes that that the fair values of assets and
liabilities that are on the financial statements classified as current
approximates their carrying values because of the short-term maturity of
these assets and liabilities. The fair values of non-current assets and
liabilities that are financial instruments, including restricted cash,
long-term debt and notes payable related parties closely approximates their
carrying value.
F-24
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENTLY ISSUED ACCOUNTING REQUIREMENTS
In June 2005, the EITF issued EITF Issue No. 05-06, "Determining the
Amortization Period for Leasehold Improvements Purchased after Lease
Inception or Acquired in a Business Combination" ("EITF 05-06"). EITF 05-06
provides that the amortization period for leasehold improvements acquired
in a business combination or purchased after the inception of a lease be
the shorter of (a) the useful life of the assets or (b) a term that
includes required lease periods and renewals that are reasonably assured
upon the acquisition or the purchase. The provisions of EITF 05-06 are
effective for leasehold improvements purchased or acquired beginning July
2005. The adoption of EITF 05-06 did not have a material impact on the
Company's consolidated financial statements.
In October 2005, the FASB posted FASB Staff Position (FSP) 13-1, which
requires that rental costs incurred during and after a construction period
for the right to control the use of a leased asset during and after
construction of a lessee asset to be recognized as rental expense. The
provisions of FSP 13-1 shall be applied to the first reporting period
beginning after December 15, 2005. The Company's existing accounting policy
for rental costs incurred during and after the construction period conforms
to FSP 13-1. The adoption of FSP 13-1 will not have a material impact on
the Company's consolidated financial statements.
In April 2004, the EITF reached final consensus on EITF 03-06,
"Participating Securities and the Two-Class Method under FASB Statement No.
128," which requires companies that have participating securities to
calculate earnings per share using the two-class method. This method
requires the allocation of undistributed earnings to the common shares and
participating securities based on the proportion of undistributed earnings
that each would have been entitled to had all the period's earnings been
distributed. EITF 03-06 is effective for fiscal periods beginning after
March 31, 2004 and earnings per share reported in prior periods presented
must be retroactively adjusted in order to comply with EITF 03-06. The
Company adopted EITF 03-06 for the quarter ended June 27, 2004, however
there has been no impact on the Company's financial statements as the
preferred shares are not participating securities.
On December 16, 2004, the Financial Accounting Standards Board (FASB)
issued FASB Statement No. 123 (revised 2004), Share-Based Payment, which is
a revision of FASB Statement No. 123, Accounting for Stock-Based
Compensation. Statement 123(R) supersedes APB No. 25, and amends FASB
Statement No. 95, Statement of Cash Flows. Generally, the approach in
Statement 123(R) is similar to the approach described in Statement 123.
However, Statement 123(R) requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the
statement of operations based on their fair values. Pro forma disclosure is
no longer an alternative.
As permitted by Statement 123, we currently account for share-based
payments to employees using APB No. 25's intrinsic value method and, as
such, generally recognize no compensation cost for employee stock options.
F-25
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Accordingly, the adoption of Statement 123(R)'s fair value method may have
a significant impact on our results of operations, although it will have no
impact on our overall financial position. The impact of adoption of
Statement 123(R) cannot be predicted at this time because it will depend on
levels of share-based payments granted in the future. However, had we
adopted Statement 123(R) in prior periods, the impact of that standard
would have approximated the impact of Statement 123 as described in the
disclosure of pro forma net income and earnings per share above.
We expect to adopt Statement 123(R) in the first quarter of 2006.
3. FURNITURE, EQUIPMENT AND IMPROVEMENTS, NET
Furniture, equipment and improvements at December 25, 2005 and December 26,
2004 consisted of:
2005 2004
------------- -------------
Furniture, fixtures and equipment $ 10,028,000 $ 9,201,000
Leasehold improvements 17,904,000 15,616,000
Construction In Progress 13,000 1,039,000
Expendables 602,000 509,000
------------- -------------
Furniture, equipment and improvements 28,547,000 26,365,000
Less, Accumulated depreciation (15,175,000) (14,501,000)
------------- -------------
Furniture, equipment and improvements, net $ 13,372,000 $ 11,864,000
============= =============
4. ACCRUED EXPENSES
Accrued Expenses at December 25, 2005 and December 26, 2004 consist of the
following:
2005 2004
---------- ----------
Accrued payroll & taxes $ 921,000 $ 829,000
Accrued sales tax 308,000 285,000
Accrued vacation 403,000 393,000
Accrued bonuses 621,000
Accrued rent 95,000 101,000
Workers compensation
claim reserves 567,000 321,000
Income taxes payable 213,000 (181,000)
Accrued preferred return 72,000 -
Other 1,333,000 800,000
---------- ----------
Total $4,533,000 $2,548,000
========== ==========
5. DEBT
At December 25, 2005 we had a bank credit facility that provided financing
in the form of a revolving line of credit in the amount of $500,000, an
irrevocable standby letter of credit in the amount of $860,000, increased
F-26
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. DEBT (CONTINUED)
to $1,010,000 in January 2006, and equipment financing in the amount of
$500,000. The facility has a one-year term, is secured by assets and is
subject to certain standard borrowing covenants. Interest is at the bank's
variable reference rate. In November 2005, we amended the equipment
financing portion increasing the amount to $600,000 for equipment to be
delivered on or before June 30, 2006, with payments to be for terms of
three to five years with interest at the bank's reference rate. In March
2006 we terminated the line of credit portion of this credit facility upon
signing a new agreement. (See Note 12 Subsequent Events.)
The credit facility is collateralized by an interest in the assets of the
Company. In connection with this facility, the Company is required to
comply with a number of restrictive covenants, including meeting certain
debt service coverage and liquidity requirements.
Debts at December 25, 2005 and December 26, 2004 are summarized as follows:
2005 2004
-------- --------
Note payable to Small Business Administration collateralized by
property, payable monthly, $1,648, including interest at 4.0%,
due September 23, 2006. $ 12,000 $ 31,000
Note payable to lessor, uncollateralized, payable monthly,
1,435, including interest at 10.0%, due April 30, 2013. 99,000 106,000
Note payable to GMAC had an original principal amount of
201,948. This note carries an interest rate of 10.3% per
annum. The note has defined monthly payment terms of
4,068 with the final payment on the first of January 2005. - 4,000
Note payable for equipment, payable monthly, $15,396,
including interest at 10.8%, due December 1, 2005. - 158,000
Note payable to Union Bank under the equipment financing
portion of the credit facility, payable in monthly installment of
982, including interest at 7.49%, due December 2009 41,000 45,000
Note payable to Union Bank second draw under the equipment
financing portion of the credit facility, payable in monthly
installments of $2,293 including interest at 8.14%, due May
2010 102,000 -
-------- --------
254,000 344,000
Less, Current portion of long-term debts 48,000 196,000
-------- --------
Long-term portion $206,000 $148,000
======== ========
F-27
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. DEBT (CONTINUED)
Principal maturities of long-term debt are as follows:
Year Ending December
--------------------
2006 $ 48,000
2007 40,000
2008 43,000
2009 47,000
2010 24,000
Thereafter 52,000
--------
Total $254,000
========
6. RELATED PARTIES
Debts with related parties at December 25, 2005 and December 26, 2004
consisted of:
2005 2004
-------- ----------
Uncollateralized note payable to officer/Board member/major
shareholder, with interest payable at a rate of 10% per annum.
The note payable and interest is due on June 30, 2006.
Interest on this loan of $17,500 remains unpaid and is included
in accrued expenses. $ 70,000 $ 70,000
Uncollateralized subordinated note payable to officer/Board
member/major shareholder, with interest payable at a rate of
7.0% per annum. The note payable and interest is due on
June 30, 2006. Interest on this loan of $33,431 remains
unpaid and is included in accrued expenses. 85,000 85,000
Collateralized subordinated note and mandatorily redeemable
capital payable to a member of Chicago - The Grill on the Alley
LLC. The original principal amount of the note was $1,699,000.
Although $1,190,000 of the note was converted to equity in
February 1999, the LLC is obligated to repay the capital on
terms similar to the original note. The note and capital bear
monthly payments of $20,972, including interest at 8% per
annum. The note will mature on April 1, 2010. The Company
guaranteed repayment of the loan and capital on behalf of
Chicago - The Grill on the Alley, LLC and issued 203,645
warrants to acquire common stock at $4.00 per share. The fair
value of the warrants ($322,000) has been recorded as a
discount to the obligation which is being accreted to interest
expense over the term of the loan. 828,000 968,000
-------- ----------
983,000 1,123,000
Less, Current portion of notes payable - related parties 312,000 294,000
-------- ----------
Long-term portion $671,000 $ 829,000
======== ==========
F-28
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. RELATED PARTIES (CONTINUED)
Principal maturities of debts with related parties are as follows:
2006 $ 312,000
2007 179,000
2008 202,000
2009 228,000
2010 62,000
Thereafter -
----------
Total $ 983,000
==========
Interest expense incurred was $ 125,000, $174,000, and $193,000 in fiscal
years 2005, 2004 and 2003 respectively.
Two stockholders, who are also officers of the Company, have loaned the
Company money. Interest accrues on these loans and is being paid quarterly.
Interest accrued was $51,000, $104,000, and $91,000 for the fiscal years
2005, 2004 and 2003, respectively.
The holder of all of the Company's preferred stock is also a current Member
of our Board of Directors and is a part owner of the San Jose Fairmont
Hotel, the site of The San Jose Grill LLC. Lease payments made to the
Fairmont Hotel were $257,000, $160,000, and $136,000 for the fiscal years
2005, 2004 and 2003, respectively. The holder of the preferred stock is
also a part owner of the San Jose Hilton Hotel, the site of The City Bar &
Grill, which was operated under a license agreement. The license agreement
was terminated during 2004. Revenue related to the license and management
agreement was zero, $4,000, and $6,000, for the fiscal years 2005, 2004 and
2003, respectively.
In August 1998, the Company entered into an agreement (the "Agreement")
with Hotel Restaurant Properties, Inc. ("HRP") in which HRP will assist the
Company in locating hotel locations for the opening of Company restaurants.
One of the two original owners of HRP is a family member of the
above-referenced preferred stockholder of the Company. On May 11, 1999 the
HRP agreement was amended under the same terms and conditions ("HRP II")
except that HRP II is 100% owned by the family member. Both HRP and HRP II
are referred to as HRP. There were $423,000, $290,000, and $235,000 of
management fees paid to HRP on this Agreement for fiscal year 2005, 2004
and 2003, respectively. The Agreement also provides that HRP will repay to
the Company amounts advanced to managed units on behalf of HRP. Receivable
from HRP was $545,000 at December 25, 2005 and $396,000 at December 26,
2004.
The operating agreement with HRP contains a clause whereby, HRP has the
right to cause the Company to purchase HRP (the put option) at any time
there is a change in control or after May 2004 subject to certain
conditions and the Company has the right to purchase HRP (the call option)
after May 2004 subject to certain conditions.
F-29
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. RELATED PARTIES (CONTINUED)
Under the respective put and call options, the purchase price ("APP")
(principally paid in stock) of HRP will be 25% multiplied by 10 (Multiple)
times the operating income of HRP (gross receipts for the prior twelve
months less operating expenses which are averaged over a five year period),
with certain allowed exclusions from operating income minus the principal
balance of any outstanding loans (with certain allowed exclusions) to HRP.
Under the put option the Multiple may change if 87.5% multiplied by the
closing price of the Company's common stock divided by EBITDA per share is
less than 10. If the Company sells assets or stock to certain third parties
introduced by HRP which causes a change in control, then the purchase price
will be the greater of: (A) $3,000,000 or (B) the APP, not to exceed
$4,500,000. The Company concluded that the options relating to HRP would be
defined as a derivative under FAS 133. However, because the purchase price
was based on a floating price, it was determined that the value of the put
and call would be identical so long as the formula resulted in a
representative fair value of HRP.
The Company concluded that the multiple was based on fair value because the
original formula was negotiated between two parties. This fact was
reconfirmed when the HRP agreement was amended approximately three years
later at the time the Company entered into a development agreement with
Starwood Hotels and the multiple for the HRP put and call options did not
change. We believe the multiple used in the formula to be within a
tolerable range of those found in the marketplace. Therefore, management
believes that the formula is a reasonable approximation of fair value of
the HRP business that results in the put and call options having similar
values. Additionally, because fair market puts and calls have little value
on their own, any asset and liability related to these would be
insignificant. No derivative accounting is necessary in these circumstances
and therefore, no accounting recognition has been made in the financial
statements.
The Company will continue to evaluate the appropriateness of formula to
market conditions to ensure it represents fair market value, and will
continue to evaluate the formula going forward and to the extent it no
longer represents fair market value, will account for the derivative
appropriately.
7. STOCKHOLDERS' EQUITY
In June 1997, the Company completed a private placement of 50,000 shares of
common stock, 1,000 shares of Series I Convertible Preferred Stock, 500
shares of Series II, 10% Convertible Preferred Stock, 187,500 five-year
$8.00 warrants and 187,500 five-year $12.00 warrants. The aggregate sales
price of those securities was $1,500,000. The warrants expired during 2002.
The Series I Convertible Preferred Stock was convertible into common stock
at $5.00 per share. In July 2000, the holder of the Series I convertible
preferred stock converted all 1,000 shares of preferred stock into 200,000
shares of common stock.
F-30
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. STOCKHOLDERS' EQUITY (CONTINUED)
The Series II 10% Convertible Preferred Stock is convertible into common
stock commencing one year from the date of issuance at the greater of (i)
$4.00 per share, or (ii) 75% of the average closing price of the Company's
common stock for the five trading days immediately prior to the date of
conversion; provided, however, that the conversion price shall in no event
exceed $10.00 per share. The Series II, 10% Convertible Preferred Stock is
entitled to receive an annual dividend equal to $100 per share payable on
conversion or redemption in cash or, at the Company's option, in common
stock at the then-applicable conversion price. The Series II, 10%
Convertible Preferred Stock is subject to redemption, in whole or in part,
at the option of the Company on or after the second anniversary of issuance
at $1,000 per share. There were no conversions as of December 25, 2005.
Accumulated dividends in arrears totaled $426,000 and $376,000 as of
December 25, 2005 and December 26, 2004, respectively.
In July 2001, the Company completed a transaction with Starwood Hotels and
Resorts Worldwide, Inc. pursuant to which (1) the Company and Starwood
entered into a Development Agreement under which the Company and Starwood
agreed to jointly develop the Company's restaurant properties in Starwood
hotels; (2) the Company sold 666,667 shares of restricted common stock and
666,667 $2.00 stock purchase warrants to Starwood for $1,000,000.
Concurrently, the Company sold an additional 666,666 shares of restricted
common stock and 666,666 stock purchase warrants at $2.25 to other
strategic investors for $1,000,000. Proceeds reflected in the financial
statements are net of transaction costs.
Under the Development Agreement, the Company is obligated to issue to
Starwood warrants to acquire a number of shares of the Company's common
stock equal to four percent of the outstanding shares upon the attainment
of certain development milestones. Such warrants are issuable upon
execution of management agreements and/or license agreements relating to
the development and operation, and the commencement of operation, of an
aggregate of five, ten, fifteen and twenty of the Company's branded
restaurants. If the market price of the Company's common stock on the date
the warrants are to be issued is greater than the market price on the date
of the Development Agreement, the warrants will be exercisable at a price
equal to the greater of (1) 75% of the market price as of the date such
warrant becomes issuable, or (2) the market price on the date of the
Development Agreement. If the market price of the Company's common stock on
the date the warrants are to be issued is less than the market price on the
date of the Development Agreement, the warrants will be exercisable at a
price equal to the market price as of the date such warrants become
issuable. The warrants will be exercisable for a period of five years.
F-31
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. STOCKHOLDERS' EQUITY (CONTINUED)
In addition to the warrants described above, if and when the aggregate
number of Company restaurants operated under the Development Agreement
exceeds 35% of the total Daily Grill, Grill and City Grill-branded
restaurants, the Company will be obligated to issue to Starwood a warrant
to purchase a number of shares of the Company's common stock equal to 0.75%
of the outstanding shares on that date exercisable for a period of five
years at a price equal to the market price at that date. On each
anniversary of that date at which the restaurants operated under the
Development Agreement continue to exceed the 35% threshold, for so long as
the Development Agreement remains effective, the Company shall issue to
Starwood additional warrants to purchase 0.75% of the outstanding shares on
that date at an exercise price equal to the market price on that date.
WARRANTS
As of December 25, 2005, there are outstanding warrants for the purchase of
1,359,896 common shares with a weighted average exercise price of $2.22.
In February 1999, 177,083 warrants exercisable at $4.00 per share were
issued in connection with the receipt of a loan from a Member of the
Chicago - The Grill on the Alley, LLC. These warrants expired April 1,
2005.
In February 1999, 17,708 warrants exercisable at $4.00 per share were
issued in connection with the receipt of a loan from a Member of the
Chicago - The Grill on the Alley, LLC. The exercisability of these warrants
is contingent on the accepting of renewal options with regard to the
restaurant lease for the Chicago - The Grill on the Alley, LLC. These
warrants expire June 2010.
In February 1999, 8,854 warrants exercisable at $4.00 per share were issued
in connection with the receipt of a loan from a Member of the Chicago - The
Grill on the Alley, LLC. The exercisability of these warrants is contingent
on the accepting of renewal options with regard to the restaurant lease for
the Chicago - The Grill on the Alley, LLC. These warrants expire June 2015.
The fair value of all the warrants issued in connection with receiving the
loan from a member of Chicago - The Grill on the Alley, LLC have been
recognized as a debt discount and recorded as a reduction to the loan
balance. Accretion of the discount is recognized as additional interest
expense using the effective interest method.
In November 1999, 3,750 warrants exercisable at $2.00 were issued as
additional compensation in relation to a private placement memorandum.
These warrants expired in November 2004.
In connection with a $400,000 loan to the Company, the Company issued
40,000 warrants to two accredited investors in July 2000. A co-trustee for
both investors became a member of our Board of Directors in June 2001. The
warrants are exercisable for a period of four years at a price of $1.406
per share. The warrants were issued pursuant to a privately negotiated
lending arrangement with two accredited investors pursuant to the
F-32
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. STOCKHOLDERS' EQUITY (CONTINUED)
exemption from registration in Section 4(2) of the Securities Act of 1933,
as amended. In June 2004 all of these warrants were exercised in a cashless
exercise. In July 2001, an additional 32,058 warrants exercisable for a
period of four years were issued in connection with this loan at a price of
$2.77 per share. The fair value of these warrants was amortized over the
life of the loan. These warrants were exercised in 2005.
In October 2000, the Company issued 50,000 warrants to a professional
advisor for services rendered. The warrants are exercisable for a period of
four years at a price of $1.53 per share. The fair value of these warrants
was expensed as general and administrative expense in the period issued.
These warrants expired in October 2004.
In connection with a guarantee of the Company's bank lending facility, the
Company issued 150,000 warrants in July 2000 to two principal shareholders
of the Company. The warrants are exercisable for a period of four years at
a price of $1.406 per share. The warrants were issued pursuant to a
privately negotiated guarantee of the Company's loan facility by two
directors of the Company pursuant to the exemption from registration in
Section 4(2) of the Securities Act of 1933, as amended. These warrants were
exercised in March and June 2004 in cashless exercises. In August 2001, an
additional 150,000 warrants exercisable for a period of four years were
issued in connection with the guaranty at a price of $2.12 per share. The
fair value of the warrants was amortized over the life of the guarantee and
was recorded as additional interest expense. These warrants were exercised
in 2005.
In July 2001, in conjunction with the sale of restricted common stock to
Starwood Hotels and Resorts Worldwide, Inc. and other strategic investors,
the company issued 666,667 $2.00 stock purchase warrants and 666,666 $2.25
stock purchase warrants. The warrants expire in July 2006.
OPTIONS
On June 1, 1995, the Company's Board of Directors adopted the Grill
Concepts, Inc. 1995 Stock Option Plan (the "1995 Plan") and on June 12,
1998 the 1998 Stock Option Plan (the "1998 Plan") was adopted. The Plans
were approved at the 1996 and 1998 annual stockholders' meetings. These
Plans provide for options to be issued to the Company's employees and
others. The exercise price of the shares under option shall be equal to or
exceed 100% of the fair market value of the shares at the date of grant.
The options generally vest over a five-year period. In 2005, the 1995 Stock
Option Plan expired.
The terms of the option grants originally allowed the employee to exercise
the option by surrendering a portion of the vested shares in lieu of paying
cash. This cashless exercise feature required the Company to account for
its option plan using a variable accounting treatment. The terms of the
option grants allow the employee to exercise the option by surrendering a
portion of the vested shares in lieu of paying cash, subject to the terms
of the plan including the rights of the Compensation Committee to amend
grants in any manner that the committee in its sole discretion deems to not
adversely impact the option holders.
F-33
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. STOCKHOLDERS' EQUITY (CONTINUED)
On June 23, 2004, the Company's Compensation Committee, as administrators
of the Company's stock option plans, resolved that the cashless exercise
feature in the Company's stock option plan will be eliminated for all
currently outstanding and future grants, and a notification was
subsequently given to all employees on July 30, 2004. Effective with this
date, the Company reverted back to accounting for its options under the
fixed accounting treatment.
At December 25, 2005 a total of 862,500 common shares are reserved for
issuance pursuant to these plans. Transactions during the fiscal years
2005, 2004 and 2003 under the Plans were as follows:
2005 2004 2003
-------------- -------------- ---------------
Weighted- Weighted- Weighted-
Average Average Average
Option Option Option
Number Exercise Number Exercise Number Exercise
of Shares Price of Shares Price of Shares Price
---------- -------- ---------- ------ ---------- ------
Options outstanding at
Beginning of year 678,425 $ 2.69 716,625 $ 2.81 669,975 $ 2.89
Options granted - price
equals fair value 148,500 4.06 212,000 2.79 89,250 1.96
Options granted - price greater
than fair value - - - - - -
Options exercised
(13,200) 2.20 (50,000) 2.33 - -
Options cancelled (101,450) 3.31 (200,200) 3.34 (42,600) 2.27
---------- ---------- ----------
Options outstanding at end of
year 712,275 2.89 678,425 2.69 716,625 2.81
========== ========== ==========
Options exercisable at end of
year 441,675 404,815 427,630
Options available for grant at
end of year 87,025 394,075 355,875
F-34
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. STOCKHOLDERS' EQUITY (CONTINUED)
The following table summarizes information about stock options outstanding
at December 25, 2005:
Options Outstanding Options Exercisable
------------------------------------------- ----------------------------
Number Weighted- Number
Outstanding at Average Weighted- Outstanding at Weighted-
Range of December 25, Remaining Average December 25, Average
Exercise Price 2005 Contractual Life Exercise Price 2005 Exercise Price
--------------- ------------- ---------------- -------------- ------ ---------------
$ 1.25 1,750 4.5 $ 1.25 1,750 $1.25
$ 1.55 44,800 4.7 $ 1.55 44,800 $1.55
$ 1.65 96,900 5.5 $ 1.65 65,300 $1.65
$ 1.70 37,150 7.4 $ 1.70 14,500 $1.70
$ 2.19 52,850 5.7 $ 2.19 40,000 $2.19
$ 2.23 50,000 8.6 $ 2.23 10,000 $2.23
$ 2.46 19,000 2.5 $ 2.46 19,000 $2.46
$ 2.75 5,000 - $ 2.75 5,000 $2.75
$ 2.86 70,450 6.7 $ 2.86 34,450 $2.86
$3.14 - $3.45 168,500 5.1 $ 3.22 123,500 $3.18
$4.00 to $4.68 148,250 6.9 $ 4.20 65,750 $4.17
$5.36 to $14.00 17,625 1.2 $ 6.40 17,625 $6.40
8. PENSION PLAN
Effective January 1, 1996, the Company established the Grill Concepts, Inc.
401(k) Plan (the "Plan"), a defined contribution savings plan, which is
open to all employees of the Company who have completed one year (1,000
hours in that year) of service and have attained the age of 21. The Plan
allows employees to contribute up to the lesser of the Internal Revenue
Code-prescribed maximum amount or 20% of their income on a pre-tax basis,
through contribution to the Plan. The Company's contributions are
discretionary. For the years 2005, 2004 and 2003, the Company made no
contributions to the Plan.
9. COMMITMENTS AND CONTINGENCIES
The Company leases most of its restaurant facilities and corporate offices
under non-cancelable operating leases. The restaurant leases generally
include land and building, require various expenses incidental to the use
of the property, and certain leases require contingent rent above the
minimum lease payments based on a percentage of sales. Certain leases also
contain renewal options and escalation clauses. Lease escalation clauses
based on changes in the consumer price index are accounted for as
contingent rentals.
The aggregate minimum lease payments under non-cancelable operating leases
are as follows:
F-35
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Fiscal Year Ending
------------------
2006 $ 3,647,000
2007 3,751,000
2008 3,573,000
2009 3,273,000
2010 2,788,000
Thereafter 13,107,000
----------
Total $30,139,000
==========
Rent expense was $3,898,000, $3,689,000, and $3,290,000 for fiscal years
2005, 2004 and 2003, respectively, including $632,000, $712,000, and
$565,000 for 2005, 2004 and 2003, respectively, for contingent rentals
which are payable on the basis of a percentage of sales in excess of base
rent amounts.
Restaurants such as those operated by the Company are subject to litigation
in the ordinary course of business, most of the related costs the Company
expects to be covered by its general liability insurance. However, punitive
damage awards are not covered by general liability insurance. Punitive
damages are routinely claimed in litigation actions against the Company.
There can be no assurance that punitive damages will not be given with
respect to any actions currently pending or that may arise in the future.
In June 2004, one of our former hourly restaurant employees filed a class
action lawsuit against us in the Superior Court of California of Orange
County. We requested and were granted a motion to move the suit from Orange
County to Los Angeles County. The lawsuit was then filed in the Superior
Court of California of Los Angeles in December 2004. The plaintiff has
alleged violations of California labor laws with respect to providing meal
and rest breaks. The lawsuit sought unspecified amounts of penalties and
other monetary payments on behalf of the plaintiffs and other purported
class members. We believe that all of our employees were provided with the
opportunity to take all required meal and rest breaks. The case has been
placed in a stay status pending the outcome of a review by the California
Supreme Court on appealed cases of the same nature. We intend to vigorously
defend our position in all of these matters although the outcome cannot be
ascertained at this time.
The Company has three suppliers which account for a majority of our
purchases. The Company has a policy of strengthening its supplier
relationships by concentrating its purchases over a limited number of
suppliers in order to maintain quality, consistency, and cost controls and
to increase the suppliers' commitment to the Company. The Company relies
upon, and expects to continue to rely upon, several single source
suppliers.
F-36
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company plans on new restaurant openings during 2006. The restaurants
will be structured as owned, joint ventures, LLCs or management agreements.
In connection with the building of the restaurants, the Company may be
obligated for a portion of the start-up and/or construction costs.
In order to better manage the cost of our workers compensation expense,
commencing in 2004, we have altered our workers compensation coverage to
substantially increase our per event and aggregate deductibles. As a
result, we expect to substantially reduce our recurring cost of workers
compensation insurance. On the other hand, we will have substantially
higher exposure to losses resulting from claims under that policy should
those claims exceed our prior deductible levels.
10. INCOME TAXES
The provisions for income taxes for the fiscal years ended December 25,
2005, December 26, 2004 and December 28, 2003 are as follows:
2005 2004 2003
-------- ------- -------
Current - federal $577,000 $ - $ -
Current - state 179,000 65,000 89,000
-------- ------- -------
Subtotal - current $756,000 $65,000 $89,000
-------- ------- -------
Deferred - federal (577,000) - -
Deferred - state - - -
-------- ------- -------
Subtotal - deferred (577,000) - -
Total provision $179,000 $65,000 $89,000
======== ======= =======
The following is a reconciliation of taxes at the U.S. federal statutory
rate and the effective tax rate:
2005 2004 2003
--------- ---------- ----------
Taxes at federal tax rate $ 190,000 $ (243,000) $(166,000)
State tax net of federal benefit 455,000 43,000 59,000
Variable incentive stock option --- 29,000 77,000
Change in valuation allowance (222,000) 22,000 76,000
General business and tip tax
credit (160,000) (48,000) (181,000)
Minority Interests (190,000) 186,000 207,000
Other 106,000 76,000 17,000
--------- ---------- ----------
Income tax provision $ 179,000 $ 65,000 $ 89,000
========= ========== ==========
F-37
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. INCOME TAXES (CONTINUED)
Deferred tax assets and liabilities consist of the following as of December
25, 2005 and December 26, 2004:
2005 2004
-------------------- --------------------
Deferred tax assets:
Net operating loss $ 602,000 $ 474,000
Fixed Assets 1,151,000 653,000
Intangibles 89,000 143,000
General business credit 1,234,000 1,364,000
Other 991,000 936,000
-------------------- --------------------
Total gross deferred tax
assets 4,067,000 3,570,000
Less, Valuation allowance 3,348,000 3,570,000
-------------------- --------------------
Net deferred tax assets 719,000 --
Deferred tax liabilities:
Partnerships (142,000) --
-------------------- --------------------
Net deferred tax assets
and liabilities $ 577,000 $ -
==================== ====================
At December 25, 2005, the Company has available federal and state net
operating loss carryforwards of $ 1,084,000 and $3,991,000 respectively
that may be utilized to offset future federal and state taxable earnings.
Federal net operating losses begin to expire in 2014. The remaining state
net operating losses began expiring in 2003. At December 31, 2005, the
Company has available federal general business credit carryforwards of
$1,234,000 that may be utilized to offset future federal tax liabilities.
These credits expire beginning in 2014 through 2024. Due to changes in the
Company's state effective tax rate, the deferred tax assets were revalued
at December 31, 2005 using a state effective tax rate, net of federal
taxes, of 3.85%. At December 26, 2004 the deferred tax assets were valued
using a state effective tax rate, net of federal taxes, of 6.6%. The state
effective tax rate will vary from year to year as the Company's operations
are conducted in numerous states with different tax rates. A valuation
allowance has been established to reduce net deferred tax assets to the
amount expected to be realized.
Due to its history of losses, the Company does not believe that
sufficient evidence exists to conclude that recoverability of its net
deferred tax assets is more likely than not. Consequently, the Company has
provided valuation allowances of $3,348,000 and $3,570,000 for the years
ended December 25, 2005 and December 26, 2004, respectively, covering its
deferred tax assets. Pursuant to Interal Revenue Code Sections 382 and 383,
the annual use of Grill Concepts, Inc.'s net operating loss and credit
carryforwards may be limited if there is a greater than 50% cumulative
change in ownership. However, the Company believes that any such
limitations would not have a material impact on the financial statements.
11. STORE OPENINGS AND CLOSINGS
OPENINGS
In connection with the building of a new restaurant, The Daily Grill at
Continental Park, LLC was formed for the operation of a Daily Grill
restaurant in El Segundo, California. The construction of the restaurant
was financed through a combination of equity capital and tenant improvement
allowances. The restaurant opened January 16, 2003.
The Company began management of a Portland, Oregon hotel-based Daily Grill
restaurant in September 2003. This was the second restaurant opened under
the Starwood agreement.
F-38
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. STORE OPENINGS AND CLOSINGS (CONTINUED)
The Company opened an owned hotel-based Daily Grill restaurant in the Hyatt
Bethesda in Bethesda, Maryland. The construction was financed by $1.8
million tenant improvement allowance which was treated as a lease incentive
and recorded as a long-term liability which will be amortized over the life
of the lease. The restaurant opened January 19, 2004.
The Company began management of a Long Beach, California hotel-based Daily
Grill restaurant in November 2004.
The Company signed a lease in April 2004 to open an owned Daily Grill in an
office park in Santa Monica, California. The construction was financed by a
$2.2 million tenant improvement allowance which was treated as a lease
incentive and recorded as a long-term liability which will be amortized
over the life of the lease. The restaurant opened March 14, 2005.
In connection with the building of a new restaurant the 612 Flower Daily
Grill, LLC was formed for the operation of a Daily Grill restaurant in
downtown Los Angeles, California. The construction of the restaurant was
funded through a combination of equity capital and tenant improvement
allowances. The restaurant opened May 31, 2005.
The Company signed a lease in September 2005 to open a owned Grill
restaurant in a shopping mall in Dallas, Texas. Construction of the
restaurant will be funded primarily through a tenant improvement allowance.
The restaurant is scheduled to open in summer of 2006.
CLOSINGS
In July 2005, the lease for the La Cienega Daily Grill expired and was not
renewed.
12. SUBSEQUENT EVENTS
NEW FINANCING AGREEMENT
On March 10, 2006, Grill Concepts, Inc. (the "Company") entered into a
credit agreement (the "Credit Agreement") with Diamond Creek Investment
Partners LLC (the "Lender").
The Credit Agreement provides for a revolving term loan (the "Loan") to the
Company of the lesser of (1) $8.0 million, or (2) 2.25 times the Company's
trailing 12 month EBITDA. Funds may be borrowed under the Credit Agreement,
subject to satisfaction of all conditions of funding, in minimum monthly
advances of $500,000. Proceeds of the Loan may be used to pay expenses of
the Loan and for general corporate purposes. The interest rate on the Loan
is, at the option of the Company and subject to certain limitations on the
use of LIBOR based loans, equivalent to either (1) prime rate, but not less
than 7%, plus an applicable margin, or (2) the London Interbank Offered
Rate, but not less than 4%, plus an applicable margin. The margin, in each
case, varies based upon the Company's leverage ratio (funded debt to
F-39
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. SUBSEQUENT EVENTS (CONTINUED)
EBITDA, each as defined) and ranges from 2.75% to 3.50% with respect to
prime rate loans and 5.50% to 6.25% with respect to LIBOR loans. The
current interest rate is equal to 10.5% and will be adjusted quarterly
commencing in the fourth quarter of 2006.
The Credit Agreement provides that the Company will pay all expenses
incurred in connection with the Loan, including expenses incurred by the
Lender. By separate agreement, the Company agreed to pay certain fees
associated with the Loan, including a loan fee of $120,000, an unused line
fee of 0.5% of the unused portion of the credit facility payable monthly, a
loan servicing fee of $3,000 per month.
The Loan matures, and is payable in full, on March 9, 2011 subject to
mandatory prepayment to the extent, if any, that the outstanding principal
balance of the Loan exceeds 2.25 times trailing 12 month EBITDA or upon the
occurrence of certain defined extraordinary events. The Company may prepay
amounts owing under the Credit Agreement subject to payment of a prepayment
premium of (1) 3% with respect to prepayments occurring on or before March
9, 2007, and (2) 1% with respect to prepayments occurring after March 9,
2007 and on or before March 9, 2008.
The Company's obligations under the Credit Agreement are secured by a first
lien on all of the Company's assets, including all of the capital stock and
other equity interests held by the Company in its subsidiaries, subject to
existing liens on such assets. The Loan requires the Company to comply with
certain ordinary lending covenants. These include, among others, financial
covenants relating to maximum debt to EBITDA ratio, minimum EBITDA and
maximum capital expenditures. The Company must also comply with certain
information requirements, including providing periodic financial statements
and projections as well as notices of defaults, litigation and other
matters, maintenance of insurance and compliance with laws as well as
limitations on liens and encumbrances, indebtedness, dispositions,
dividends and retirement of capital stock, consolidations and mergers,
changes in nature of business and other operating, financial and structural
limitations.
Events of default in the Credit Agreement include, among others, (a) the
failure to pay when due the obligations owing under the Credit Agreement,
(b) the failure to perform and not timely remedy certain covenants, (c)
certain cross defaults or cross accelerations, (d) the occurrence of
bankruptcy or insolvency events, (e) the failure to make certain payments,
or the occurrence of certain events, relating to retirement plans, (f)
certain adverse judgments against the Company or any of its subsidiaries,
(g) certain changes in ownership of the Company's stock or the board of
directors, or (h) the occurrence of, and failure to remedy, a Material
Adverse Effect (as defined in the Credit Agreement). Upon the occurrence of
an event of default, the Lender may terminate the loan commitment and
declare the Loan due and payable in full.
On March 31, 2006, the Company borrowed $1 million under the terms of the
Credit Agreement with Diamond Creek Investment Partners LLC. The borrowed
funds were primarily used to retire $930,132 of collateralized subordinated
notes and manditorily redeemable capital obligations owed to The Michigan
Avenue Group ("MAG") by the Company's subsidiary Chicago - The Grill on the
Alley LLC ("Chicago Grill LLC"), and guaranteed by the Company (Note 6),
with the balance used for general working capital. The retired obligations
related to the initial funding provided by MAG, as a member/investor in
Chicago Grill LLC, with respect to the Company's The Grill on the Ally
restaurant in Chicago.
MANAGEMENT CHANGE; EMPLOYMENT AGREEMENT
On March 3, 2006, Grill Concepts, Inc.'s Compensation Committee approved,
and on March 13, 2006 Grill Concepts entered into, an amended employment
agreement with Philip Gay, Executive Vice President and Chief Financial
F-40
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. SUBSEQUENT EVENTS (CONTINUED)
Officer of the company. The amended employment agreement will be effective
as of, and was entered in contemplation of, Mr. Gay's pending assumption of
the positions of President and Chief Executive Officer of the company to be
effective following the company's annual shareholders meeting on June 22,
2006. The term of the amended employment agreement will run through
December 31 2009.
Under the terms of the employment agreement, effective June 22, 2006, Mr.
Gay's compensation will consist of (1) a base annual salary of $275,000
during the first year, increasing to $300,000, $325,000 and $350,000 on
each succeeding anniversary of the effective date; (2) performance-based
bonuses in an amount up to 50% of his applicable salary based on metrics
established annually by the Compensation Committee; (3) a stock option to
purchase 50,000 shares of common stock at $3.19 per share over a period of
ten years and vesting 1/3 on each of June 22, 2007, June 22, 2008 and June
22, 2009; (4) use of a company automobile plus payment of repair,
maintenance and insurance costs with respect to such automobile in an
amount not to exceed $10,000 annually; (5) a term life insurance policy in
the amount of $1,000,000; (6) participation in all group life, health,
accident, disability, liability or hospitalization insurance plans, pension
plans, severance plans or retirement plans available to the highest level
executives of the company; (7) five weeks of paid vacation; and (8)
participation in any and all other benefit plans adopted from time to time
by the company for the benefit of its employees.
NEW CLASS ACTION LAWSUIT
A Class Action complaint was filed in the Superior Court of the State of
California for the County of Los Angeles on March 15, 2006. The plaintiff
and those similarly situated (Servers) complain that the company has
violated the labor code by having Servers "Tip Out" Bartenders and
Expeditors a percentage of their tips to these employees who provide no
direct table service. The complaint has labeled this act as "Tip-pooling."
The company has not yet been served with this complaint.
13. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized unaudited quarterly financial data for fiscal years 2005 and
2004 is as follows:
Quarter Ended
-------------
March 27, June 26, September 25, December 25,
2005 2005 2005 2005
Total revenues 17,212,000 18,871,000 15,410,000 19,195,000
Income (loss) from operations 706,000 66,000 (117,000) 32,000
Net income (loss) 682,000 125,000 (188,000) 320,000
Basic net income (loss) per share $ 0.12 $ 0.02 $ (0.04) $ 0.05
Diluted net income (loss) per
share $ 0.11 $ 0.02 $ (0.04) $ 0.05
F-41
GRILL CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 28, June 27, September 26, December 26,
2004 2004 2004 2004
----------- --------------- -------------- -----------
Total revenues 16,499,000 15,390,000 14,644,000 17,126,000
Income (loss) from operations 59,000 (274,000) (245,000) 21,000
Net income (loss) 117,000 (131,000) (178,000) 230,000
Basic net income (loss) per share $ 0.02 $ (0.02) $ (0.03) $ 0.04
Diluted net income (loss) per
share $ 0.02 $ (0.03) $ (0.03) $ 0.04
Note: Due to rounding, the sum of individual columns may not equal the earnings
per share for the year.
F-42